ACCOUNTING FOR NON-

ACCOUNTING PEOPLE

BY
PB SAN JOSE, JR., cpa, mba, cpv
ACCOUNTING FOR NON-
FINANCIAL PEOPLE
 Accounting Defined:
 Accounting is the process of:
 1. Identifying
 2. Measuring, and
 3. Communicating
 Economic information to permit informed
judgment and decision by users of the
information. (American Accounting Association)
Accounting Defined
 1. Economic Information
 Refers to economic activities or business
transactions that have an effect on the business
assets, liabilities, income, expense or/and equity.
 a. Internal transactions-economic events that
take place within the enterprise.
 b. External transactions-economic events
involving one enterprise and another enterprise.
Accounting Defined
 1. Identifying Economic Event
 Is the process of recognition or non-
recognition of a business activities.
 We only recognize business activities or
events when they affect on the firm’s assets,
liabilities, income, expense or/and equity
and can be quantified or expressed in terms
of a unit or measure.
Accounting Defined
 1. Measuring Economic Event:
 Is the process of assigning of peso
amounts to the economic or business
transactions and events.
Accounting Defined
 Communication Economic Event
 Is the process of preparing and distributing
accounting reports to potential users of
accounting information. (investors, owners,
management, creditors, government units
and other interested people).
Types of Business Activities
 1. Service Companies
 Perform services for a fee.
 2. Merchandising Companies
 Purchase goods that are ready for sale
 (no additional processing is involved)
 3. Manufacturing Companies
 Buy raw materials and convert or process these
 raw materials (by adding labor and overhead)
 into finished products/goods.

FORMS OF BUSINESS
ORGANIZATIONS

 1. Sole Proprietorship
 2. Partnership
 3. Corporation
Sole Proprietorship
 Is owned by one individual.
 Advantages:
 1. No formal charter is required.
 2. Organizational costs are minimal.
 3. Profits and controls are not shared with others.
 4. The income is taxed as personal income.
 5. Confidentiality is maintained.
 Disadvantages:
 1. Amount of capital is limited.
 2. Unlimited liability.
 3. Life of the business is limited to the life of the owner.
 4. The owner must be “jack of all trades.”
Sole Proprietorship
 How to organize a sole proprietorship
 1. Register trade name with the DTI.
 2. Get business permit from the local
government unit.
 3. Register with the BIR as VAT or Non-
VAT business entity.
 4. Register with the BIR –simplified books
of accounts.
PARTNERSHIP
 Is the association of two or more persons
who bind themselves to contribute money,
property or industry to a common fund with
the intention of dividing the profits among
themselves.
 Basic Types of Partnership
 1. General Partnership
 2. Limited Partnership
General Partnership
 Is the type of partnership where the
liabilities of the (general) partners extend
beyond their partnership contributions (up
to their personal assets).
Limited Partnership
 Is the type of partnership whereby the
partners are limited partners with at least
one general partner. The liabilities of the
limited partners are limited only up to their
partnership contributions.
Types of Partners
 1. Capitalist Partner
 Whose contributions are in the forms of money
or property.
 2. Industrial Partner
 Whose contributions are in the form of industry
or skills.
 3. Capitalist-Industrial Partner
 Whose contributions are in the forms of money
or property and skills.
Partnership
 How to organize a Partnership:
 1. Register with the Securities and Exchange Commission
(SEC) the partnership’s Article of Co-Partnership.
 2. Get business permit from the local government unit.
 3. Register with the BIR as to VAT or Non-VAT entity.
 4. Register with the BIR books of accounts, official
receipts and other business forms to be used in the
operations.
 5. Comply with the requirements of other government
units (such as SSS. etc.)
Causes of Partnership Dissolution
 1. Admission of a new partner.
 2. Withdrawal or retirement of a partner.
 3. Death, incapacity, or bankruptcy of a
partner.
 4. Incorporation of the partnership into
corporation.
 5. Agreement of the partners.
CORPORATION
 Is an “artificial being created by operation
of law having the right of succession and
the powers, attributes, and properties
expressly authorized by law or incident to
its existence.”
How to Organize a Corporation
 1. Register with SEC, the corporate Articles of
Incorporation and By-Laws.
 (together with the corporate treasurer’s affidavit that at
least 25% of the authorized capital stocks had been
subscribed and at least 25% of the subscribed stocks had
been paid up).
 2. Get business permit from local government unit.
 3. Register with BIR as VAT or Non-VAT entity.
 4. Register with BIR corporate books of accounts, official
receipts and other business forms to be used in the
operations.
 5. Comply with the requirements of other government
units (such as SSS, etc.)
Components of a Corporation
 1. Corporators
 2. Incorporators
 3. Stockholders
 4. Members
 5. Board of Directors
 6. Board of Trustees
 7. Promoters
 8. Underwriters (investment bankers)
Taxes for Partnership & Corporation
 Partnership (except professional general
partnership-partners are taxed as individuals) and
corporation are taxed 30% of net taxable income.
 Partnership and corporation unless specifically
VAT-Exempted by law are subject to payment of
12% VAT on sales (net of input taxes from
purchases) to be paid every quarter. They are also
required to withhold taxes from the compensation
of their regular employees. SSS premiums and
other mandatory deductions have to be complied
with.
Understanding Financial Statements
 The three basic financial statements are:
 1. Income Statement
 2. Balance Sheet
 3. Statement of Cash Flows
 Objective of Financial Statements
 Is to provide quantitative information about the
financial position, performance, changes in
financial position of an enterprise that is useful to
a wide range of users in making economic or
business decisions.
Income Statement
 Is the financial statement that shows the
result of operation of a business entity for a
specific given period of time (for the Period
Covering January 1, 2008 to December 31,
2008 or for the Year Ending December 31,
2008).
 The income statement shows the revenues,
expenses, and the net income (loss) for the
specific given period of time.
Balance Sheet
 Shows the financial condition or position of
the firm as of a particular date (As of
December 31, 2008).
 It shows the balances of the assets,
liabilities and equity accounts.
Statement of Cash Flows
 Shows the detailed sources and utilization of the cash asset
from its operating, investing, and financing activities.
 Operating activities-involve activities from the business
day to day operations.
 Investing activities-involve the purchase and sale of fixed
assets (such as property and equipment and the like).
 Financing activities-involve the sale the company’s own
preferred and common stocks, bonds, mortgages and other
long-term debt instruments and collection of loans made to
other entities. They also include cash outflows for
repayments of long-term loans, reacquisition of treasury
stocks and payment of dividends.
Accounting Theories, Assumptions
and Concepts
 Two Basic Assumptions:
 1. Going Concern Assumption
 When financial statements are prepared, the
assumption is that the firm will be in operation
from year to year.
 2. Accrual Assumption
 This assumption states that income and
expenses are recognized in the financial
statements when they are realized and incurred,
respectively, even if there is no cash receipt or
payment involved.
Basic Accounting Concepts
 Time Period or Periodicity
 States that financial statements are
prepared at the end of the business
operating period which is normally one
year. (interim financial reports are
sometimes prepared on a monthly, quarterly
or semi-annually for internal purposes).
Business Entity Concept
 States that the business entity has a separate
and distinct personality different from its
owners. (a corporation has a distinct and
separate personality from its stockholders)
Materiality or Full Disclosure
Concept
 States that all significant circumstances and
events that would make a difference to
financial statement users should be
disclosed.
Prudence or Conservatism Concept
 States that profits should not be anticipated
but provision for possible losses should be
made. (like provisions for bad debts and
depreciations).
Cost Concept
 States that business transactions should be
normally recorded at cost. (Recently, some
accounting rules had been changed allowing
recording certain assets at market value).
Qualitative Characteristics of
Financial Statements
 Understandability
 Financial statements should be prepared in
such manner where they could be easily
understood by the different users.
 The account titles used and the account
classification should follow the uniform
accounting system used internationally.
Relevance
 States that financial statements should be
prepared on time otherwise, they will lose
that capacity to influence the decision
makers.
 The financial information is relevant when
it can make a difference in a business
decision.
Reliability
 States that financial statements should be
free from material misstatement of facts.
 The financial information to be depended
and reliable, it should be verifiable, neutral,
factual and faithful representation of what it
purports to be.
Comparability
 States that the firm should use consistently
the same accounting principles and methods
from year to year in order that it can
compare its financial statements of the
current year with its prior years. (example
depreciation method or inventory valuation
methods).
Accounting Cycle
 Is the process of collecting and processing transaction data up to the
preparation of the financial statements.

 Steps –Accounting Cycle:

 1. Identification/analysis of the transactions (source documents)

 2. Recording of the transactions to respective journals..
 3. Posting entries from the journals to the ledger accounts.
 4. Prepare unadjusted trial balance.
 5. Prepare/post adjusting entries.
 6. Prepare adjusted trial balance.
 7. Prepare income statement.
 8. Prepare balance sheet.
Recording Financial Transactions
 Double-Entry Accounting System
 Is a system whereby each business
transaction is recorded in two or more
accounts with equal debits and credits.
 The balance sheet or accounting equation
(Assets = Liabilities + Equity) is the basis
for double-entry accounting. The asset side
of the B/S is the debit side and the liability
and equity side is the credit side.
Chart of Accounts
 Account is an accounting device where similar
nature of transactions is posted and summarized.
These are called Ledger Accounts.
 Accounts are generally classified as ff:
 1. Assets
 2. Liabilities
 3. Revenue/Income
 4. Expenses
 5. Owners’ Equity
Debits and Credits
 Debit is the left side of an account.
 Credit is the right side of an account.
 Debits (Dr.) Credits (Cr.)
 Increase Assets Decrease Assets
 Decrease Liabilities Increase Liabilities
 Decrease Income Increase Income
 Increase Expense Decrease Expense
 Decrease Equity Increase Equity
Balance Sheet
 Anatomy of a Balance Sheet

 ASSET = LIABILITIES + NET WORTH

 Assets - Anything owned by the firm with
 economic value.
 Liabilities – Anything owed by the firm with
 economic value
 Net Worth – The difference between assets and
 liabilities, representing the owner’s
 equity.
 PSJ COMPANY
 Balance Sheet
 As of December 31, 2008

 Assets Liabilities & Net Worth

 Current Assets Current Liabilities
 Cash 65,000 Accts. Payable 25,000
 Accts Rec. 10,000
 Inventory 30,000
 Total C/A 105,000 Total C/Liabilities 25,000
 Fixed Assets Fixed Liabilities
 Building 100,000 Bank Mortgage 75,000
 Total F/A 100,000 Total Liabilities 100,000
 Net Worth. Beg. 100,000
 Add: Net Profit(Loss) 5,000
 Net Worth, End 105,000
 Total Liabilities &
 Total Assets 205,000 Net Worth 205,000
Glossary of Balance Sheet Terms
 Assets - What the company owns with economic value.
 Current Assets-Include cash, accounts/notes receivable, inventories, and other
assets that can be converted into cash within the normal operating period (one
year).
 Cash/Cash Equivalents-cash money, bank accounts, and marketable securities.
 Accounts/Notes Receivable-represent monies owed to the company by its
customers for goods and services (Less provision for bad debts).
 Inventory-For retailer/wholesaler, it is the stock of salable goods on hand. For
manufacturing firm, it is the sum of raw materials, materials in process, and
finished goods on hand.
 Other Current Assets-include prepaid expenses and accrued income.
 Fixed Assets-Land, buildings, equipment, fixtures, machinery, tools, furniture,
office equipment (less salvage value and provisions for depreciations).
 Other Assets/Intangibles-include intellectual properties, such as goodwill,
patents, copyrights, and the like.
Glossary of Balance Sheet Terms
 Liabilities-Monies owed to a company by its customers for
goods and services received.
 Current Liabilities-Monies that are owed by the company
and to fall due within a year
 Other Current Liabilities include Accruals (expenses
already incurred but not yet paid).
 Fixed Liabilities-Monies that are owed by the company
and to fall due beyond one year (include mortgages, bonds
and other long-term loans).
 Net Worth-represents the owners’ equity (total assets less
total liabilities, including net profit (loss).
INCOME STATEMENT
For the Year Ending 12/31/08
 Net Sales (Gross Sales less
 Returns & Allowances) 700,000
 Less: Cost of Sales/Services 500,000
 Gross Profit 200,000
 Less: Operating Expenses
 Salaries/Wages 65,000
 Transportations 7,000
 Bad Debts 4,000
 Communications 2,000
 Depreciation 4,000
 Insurance 7,000
 Taxes & Licenses 8,000
 Advertising 3,000
 Miscellaneous 84,700 184,700
 Net Profit (Before Tax) 15,300
 Less: Tax Provisions xxx
 Net Profit (After Tax) xxx
Glossary of Income Statement Terms
 Net Sales-total volume of cash/credit sales less sales returns &
allowances.
 Cost of Sales/Services-total cost of the product/services sold/provided.
For manufacturing firm-the total costs of producing the finished
product (raw materials, direct labor and manufacturing overhead).
 For retail/wholesale of merchandise, the cost of sale is calculated by:
 (inventory beg. add purchases) less inventory end.
 Gross Profit-difference between net sales and cost of sales/services but
before deducting the operating expenses.
 Operating Expenses-the various costs of doing business.
 Net Profit (Loss)-the net amount after deducting the operating
expenses from the gross profit. If the gross profit is more than the
expenses=net profit; if the expenses are more than the gross
profit=(net loss).
Statement of Cash Flows for the
Year Ended 12/31/08
 Cash Flows from Operating Activities:
 Cash Receipts from Operating
 Activities 389,102
 Cash Payments from Operating
 Activities (311,367)
 Net Cash Provided by Operating
 Activities 77,735
Cash Flows……
 Cash Flows from Investing Activities
 Capital Expenditures (14,878)
 Purchase of Securities (476,911)
 Sale of Securities 456,960

 Net Cash Used in Investing

 Activities (34,829)
Cash Flows……
 Cash Flows from Financing
 Activities
 Issuance of Notes Payable 7,000
 Repayment of Notes Payable (7,000)
 Repurchase of Stocks (13,445)
 Dividends Paid in Cash ( 9,150)
 Net Cash Used in Financing
 Activities (22,595)
 Net Increase in Cash Balance 20,311
 Add: Cash Balance. Beginning 60,433
 Cash Balance, End (12/31/06) 80,744
Glossary of Cash Flows Terms
 Operating Cash Flows
 Cash flows from the business normal operations.
 Investing Cash Flows
 Cash flows from sale and purchase of capital assets (capital
expenditures).
 Financing Cash Flows
 Cash flows from issuance of stocks or long-term
 debt instruments (bonds, etc) and proceeds and
 repayments of long-term financings activities.
 Net Change (increase or decrease) in Cash Balance
 The net balance or total of cash flows from operating, investing and
 financing activities.
 Financial Analysis
 The basic financial statements (Balance
Sheet, Income Statement and Statement of
Cash Flows) do not provide sufficient
financial information to efficiently and
effectively operate a business. There is a
need to examine the significance of the
financial data given in these financial
statements as basis for sound business
decisions.
Financial Analysis….
 There are basic techniques in financial analysis:
 1. Comparative Analysis
 2. Vertical Analysis
 3. Ratio Analysis
 a. Liquidity Ratios
 b. Efficiency/Turnover Ratios
 c. Profitability Ratios
 d. Leverage/Solvency Ratios
 Horizontal/Vertical Analysis
 Horizontal Analysis
Is the technique for analyzing the changes (in amounts &
percentages) in the financial items in the financial
statements from one year to the next period or periods.
 Vertical Analysis
 Is the technique for analyzing the relationship of the
various components of the financial statements to the total
or common base of the financial statements for a single
period operations.
 Ratio Analysis
 Is the technique used to determine key or significant
relationship of the various elements of the financial
statements to indicate the business’ liquidity, profitability,
efficiency of operation and Long-term solvency.
 Comparative Condensed Balance
Sheet As of 12/31/07 & 12/31/08 (in
thousands)
 Inc.(Dec.)
 2008 2007 Amt. %
 Assets
 Current Assets 600 450 150 33%
 Non-Current
 Assets 700 550 150 27%
 Total Assets 1,300 1,000 300 30%
Comparative Condensed Balance
Sheet…..(in thousands)
 Inc. (Dec)
 2006 2005 Amt. %
 Liabilities & Networth
 Current Liab. 250 200 50 25%
 Non-Current 200 250 (50)
(20%)
 Total Liab. 450 450 - -
Comparative Condensed Balance
Sheet … (in thousands)
 Inc. (Dec)
 2008 2007 Amt. %
 Networth:
 Capital Stocks 500 500 - -
 Ret. Earnings 350 50 300 600%
 Total Networth 850 550 300 54%
 Total Liabilities
 & Networth 1,300 1,000 300 30%
Comparative Income Statement
For the Year Ending 12/31/08 (in
thousands)
 Sales/Other Income 1,520 102%
 Less: Sales Returns & Allow 30 2%
 Net Sales 1,490 100%
 Less: Cost of Sales 1,000 67%
 Gross Profit 490 33%
 Less: Selling/Adm. Expenses 300 20%
 Operating Income 190 13%
 Less: Interest Expense 10 .7%
 Net Income Before Tax 180 12%

Liquidity Ratios
 Measure how the business can pay its
current liabilities using its current assets.
 The most common liquidity ratios are:
 1. Current Ratio
 2. Quick Ratio

Liquidity Ratios
 Current Ratio
 Is the mathematical relationship of the current
assets to its current liabilities. It is calculated by:
 Current Assets/Current Liabilities
 = 326,062/208,854
 = 1.56 times or 1.56:1
 Means that there is P1.56 current assets for every
P1.00 of current liability. The ideal ratio is 2:1.
Liquidity Ratios…
 Quick (Acid-Test) Ratio
 Measures how current liabilities are covered by cash and
cash equivalent current assets.
 It is calculated by:
 Quick Assets/Current Liabilities
 = 294,762 / 208, 854
 = 1.41 times or 1.41:1
 Means that for every P1.00 current liability there is P1.41
quick assets available. The ideal ratio is 1:1.
 **Quick assets are current assets less inventories &
prepaid expenses.
Efficiency/Turnover Ratios
 Measure efficiency in utilization of the company’s assets
to generate revenues.
 1. Days Receivable Ratio
 Indicates how fast the company’s customers pay their
bills. It measures the average collection period for
receivables.
 It is calculated by:
 (Ave. Net Receivable/Net Sales) x 360 days
 = (85,495/1,039,500) x 360 days
 = 29.61 days
 This means that collection of receivables is done within a
month (this should be compared with the company’s credit
term).
Efficiency/Turnover Ratios…
 Inventory Turnover
 It measures the number of days a company holds
its inventory from date of purchase to date of sale.
It is calculated by:
 (Ave. Inventory/Cost of Sales) x 360 days
 = (27,175/322,000) x 360 days
 = 30.38 days
 This means that it takes an average of 30 days
from date of purchase to dispose/sell the
merchandise on stocks.
Efficiency/Turnover Ratios…
 Days Payable Ratio
 Measures the average time the company settles its
current trade liabilities (purchases on account). It
is calculated by
 = 360 days/(Cost of Sales/Ave. Accts. Payable)
 = 360/(1,335,139/140,076)
 = 37 days
 This means that it takes an average of 37 days for
the company to pay its accounts payable from date
of purchase. (this should be compared with the
credit term of the creditors).
Profitability Ratios
 Measure the company’s ability to generate
profit and return on its investments.
 The most common profitability ratios are:
 1. Gross Profit Margin Ratio
 2. Net Profit Margin Ratio
 3. Return on Investments (ROI)
 a. Return on Total Assets
 b. Return on Equity
Profitability Ratios…
 1. Gross Profit Margin
 It reflects the company’s ability to recover its
manufactured or purchased merchandise from
sales revenues. It is calculated by:
 = Gross Profit/Net Sales
 = 28,300/80,300=35%
 This means that for every P1.00 sales, the
company has realized a gross profit of P0.35 to
cover the operating expenses to realize a positive
profit margin.
Profitability Ratios…
 Net Profit Margin
 It measures the “bottom line” profit margin. It shows the
net earnings for the company’s owners or stockholders
from its sales revenues. It is calculated by:
 = Net Profit/Net Sales
 = 8,000/80,300
 = 10%
 This means that for every P1.00 sales, the company earned
a net profit P0.10 (this should be compared with the
company’s and/or industry’s standards).
Profitability Ratios….
 Return on Total Assets
 It measures the efficiency by the company in using
its total resources to generate profit. It is
calculated by:
 = Net Profit/Average Total Assets
 = 8,000/215,500
 =3.70% or P0.04 for every P1.00 sales
 This should be compared with the company’s
and/or industry standards.
Profitability Ratios…
 Return on Equity
 It measures the net earnings of the common
stockholders from their investments. It is
calculated by:
 = Net Income (available to common
stockholders)/ Ave. Stockholders’ Equity
 = 8,000/84,000
 =9.52% or P0.09 for every P1.00 sales
 This should be compared with the rate of return on
external available investment opportunities.
Other Profitability Ratios…
 Earnings Per Share
 It measures the stockholders’ earnings on a per
share basis. It is calculated by:
 =Net Income –Preferred Dividends (if
any)/Common Shares Outstanding
 = 8,000/4,600 shares
 = P1.74 per share
 This should be compared with the industry’s
standards or rate of return on other available
investment opportunities.
Other Profitability Ratios…
 Price/Earnings Ratio (P/E Ratio)
 It measures how much investors are willing pay
for the company’s stock based on its earnings. It
is calculated by:
 = Market Price/EPS
 =P12.00/P1.74
 = 6.9 Times
 This means that potential investors are willing pay
for the company’s stock equivalent to 7 times its
EPS.
Other Profitability Ratios
 Book Value Per Share
 It measures the amount of net assets available to
common stockholders (generally in case of
dissolution/liquidation). I t is calculated by:
 = Total Equity Less Preferred Stocks (if
any)/Common Stocks Outstanding
 = P88,000 – 0/4,600
 = P19.13 (this should be compared with the
stock’s market price).
Other Profitability Ratios…
 Dividend Payout Ratio
 It measures the amount of dividend paid to
stockholders against the EPS. It is calculated by:
 =Dividend Per Share Paid/EPS
 = P1.00 / P1.74
 = 57%
 This is an indication of possible expansion
programs by the company using its net retained
earnings.
Leverage/Solvency Ratios
 Measures the company’s ability to pay off
its maturing long-term debts and their
effects on the company’s long-term
stability.
 The most common leverage/solvency ratios
are: 1. Debt to Assets Ratio
 2. Debt to Equity Ratio
 3. Times Interest Earned Ratio
Leverage/Solvency Ratios..
 Debt to Assets
 Determines to what extent of the total assets
are funded through debt or borrowings. It is
calculated by:
 = Total Liabilities/Total Assets
 = 139,000/227,000
 =61% of the total assets were funded by
borrowings.
Leverage/Solvency Ratios..
 Debt to Equity (Leverage Ratio)
 It measures the amount of debt a company is
carrying as a percentage of its equity. It indicates
the margin safety of the creditors on the equity of
the company. It is calculated by:
 =Total Liabilities/Stockholders’ Equity
 = 139,000/88,000
 =1.58 Times
 This means that the company is heavily leveraged
and would find it difficult to find additional
external financing.
Leverage/Solvency Ratios…
 Times Interest Earned
 It measures how many times the company’s
earnings before interest and taxes (EBIT) can
cover interest payments. It is calculated by:
EBIT/Interest Expense
 =P15,300/P2,000
 = 7.65 Times
 This means that the company EBIT can
adequately cover its interest payment 7.65 times
but this should be related to the overall financial
solvency of the firm.
The Significance of Financial
Analysis
 The significance of financial analysis is very
important to many users of financial statements
such as:
 1. Government Agencies
 2. Bankers and Financial Institutions
 3. Shareholders, Owners, Investors
 4. Company Management
 5. Labor Movements
 6. Financial Analysts
 7. Other Interested Parties