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Finance can be defined as the science and art of managing money. (Gitman &
Zutter, 2012).
Finance
How much of their earnings they spend
- How much they save or how much they need
- How they invest their savings
- How they raise additional funds they need (Gitman)
budgeting. - Budgeting is the act of estimating revenue (in the form of their
allowance) and expenses over a period of time (in this case, on a daily basis). Good liquidity and reasonable leverage position.
Liquidity and leverage refers to the companys management of the type
FORMS OF BUSINESS ORGANIZATIONS: and amount of assets and liabilities that it will hold in the course of its
- Sole Proprietorship - A business owned by one person and operated for his operations.
or her own profit.
- Partnership - A business owned by two or more people and operated for Dividends.
profit. Holders of shares receive dividends from a corporation as returns on their
- Corporation An entity created by law owned by shareholders. investments in form of cash or other properties. Companies which have
better dividend policies are generally more attractive than companies who
Ask the learners if they recall how they can be shareholders of a corporation do not pay out dividends.
by buying stocks. Note that there may be times that companies do not pay out dividends
because of future expansions. Same with the other factors affecting share
ASK HOW AND WHERE CAN THEY BUY STOCKS? price, dividend policies should go hand in hand with other factors in
- Corporations may either be privately owned or publicly owned. determining market price.
- Privately owned corporations are often owned by family members whose
stocks may not be offered to outsiders unless consent by the family members - Competent management.
is secured. Competent managers may have any of the following attributes:
- Companies which are publicly listed are owned by unrelated investors and 1) visionary
are traded in organized exchanges like the Philippine Stock Exchange. While 2) decisive
there are many stockholders, there is generally a group of investors or a 3) people-oriented,
family which controls each listed company. 4) inspiring,
5) innovative,
For example, in the case of BPI, the biggest stockholder is Ayala Corporation 6) respected and
and in the case of Banco De Oro, it is SM Investment Corporation. Prices of 7) experienced/seasoned manager.
stocks of listed corporations are driven by several factors such as the
earnings of the companies, the prospects of the industry where these - Corporate plans that improve the business prospects.
companies operate, the general market sentiment, and the economic Example: Company A which is in the business of selling Halo-halo in the
prospects of the country, among others. Dapitan area (or any other area) for 5 years. Company A is consistently
earning profits and has a positive cash flow. When asked how Company A
1. Measurement of the shareholders wealth sees itself after 5 more years, Company A answered that it would continue to
Post the question of how do we measure shareholders wealth? Simplify the sell Halo-halo in Dapitan (or any other area).
example.
- Assume a learner bought 10 shares of Globe Telecom at PHP2,510 each on On the other hand, Company B sells Buko Juice in Katipunan area (or any
September 9, 2010. This brings his investments to PHP25,100. What happens other area different from Company As area) for 5 years. Company B is
to the value of his investment if the price goes up to PHP2,600 per share or it consistently earning profits and has a positive cash flow. When asked how
goes down to PHP2,300 per share? Company B sees itself after 5 more years, Company B answered that it has
Conclude that shareholders wealth is measured based on the current generated enough cash to expand its business to Cubao area (or any other
market price of the corporations stocks. The market price changes across area) to take advantage of the growing demand of Buko Juice in Cubao.
different periods. Hence, the value of your investment changes in different
points on time based on the market value at that time. Between Company A and Company B, which would be a better investment?
DISCUSS BRIEFLY THE ROLES OF EACH POSITION IDENTIFIED. Financing decisions include making decisions on how to fund long term
Shareholders: The shareholders elect the Board of Directors (BOD). Each investments (such as company expansions) and working capital which deals
share held is equal to one voting right. Since the BOD is elected by the with the day to day operations of the company (i.e., purchase of inventory,
shareholders, their responsibility is to carry out the objectives of the payment of operating expenses, etc.).
shareholders otherwise, they would not have been elected in that position.
Ask the learners again what the objective of the shareholders is just to The role of the VP for Finance of the Financial Manager is to determine the
refresh. appropriate capital structure of the company. Capital structure refers to how
Board of Directors: The board of directors is the highest policy making much of your total assets is financed by debt and how much is financed by
body in a corporation. The boards primary responsibility is to ensure that equity. To illustrate, show/draw the figure below:
the corporation is operating to serve the best interest of the stockholders.
The following are among the responsibilities of the board of directors:
- Suppliers credit are the amounts owed to suppliers for the inventories they 1. FINANCIAL INSTRUMENTS
delivered or services they provided. While suppliers credit is generally free When a financial instrument is issued, it gives rise to a financial asset on
of interest charges, the obligations with them have to be paid on time to one hand and a financial liability or equity instrument on the other.
maintain good supplier relationship. Such relationships should be nurtured to - A Financial Asset is any asset that is:
ensure timely delivery of inventories. Cash
An equity instrument of another entity
- Short term sources pose a trade-off between profitability and liquidity risk. A contractual right to receive cash or another financial asset from another
Because this source matures in a short period, there is a possibility that the entity.
company may not be able to obtain enough cash to pay their obligation (i.e.
liquidity risk). A contractual right to exchange instruments with another entity under
- Long term sources, on the other hand, mature in longer periods. Since this conditions that are potentially favorable. (IAS 32.11)
will be paid much later, the lenders expect more risk and place a higher
interest rate which makes the cost of long term sources higher than short Examples: Notes Receivable, Loans Receivable, Investment in Stocks,
term sources. However, since long term sources have a longer time to Investment in Bonds.
mature, it gives the company more time to accumulate cash to pay off the
obligation in the future. - A Financial Liability is any liability that is a contractual obligation:
- Hence, the choice between short and long term sources depends on the risk
and return trade off that management is willing to take. The learners will To deliver cash or other financial instrument to another entity.
learn more about this on Chapter 4: Sources and uses of funds. To exchange financial instruments with another entity under conditions
that are potentially unfavorable. (IAS 32)
Dividend Policies. Recall that cash dividends are paid by corporations to Examples: Notes Payable, Loans Payable, Bonds Payable - An Equity
existing shareholders based on their shareholdings in the company as a Instrument is any contract that evidences a residual interest in the assets of
return on their investment. Some investors buy stocks because of the an entity after deducting all liabilities. (IAS 32)
dividends they expect to receive from the company. Non-declaration of Examples: Ordinary Share Capital, Preference Share Capital
dividends may disappoint these investors. Hence, it is the role of a financial Identify common examples of Debt and Equity Instruments.
manager to determine when the company should declare cash dividends. - Debt Instruments generally have fixed returns due to fixed interest rates.
- Before a company may be able to declare cash dividends, two conditions Examples of debt instruments are as follows:
must exist: Treasury Bonds and Treasury Bills are issued by the Philippine
1. The company must have enough retained earnings (accumulated profits) government. These bonds and bills have usually low interest rates and have
to support cash dividend declaration. very low risk of default since the government assures that these will be paid.
2. The company must have cash. Corporate Bonds are issued by publicly listed companies. These bonds
usually have higher interest rates than Treasury bonds. However, these
On the other hand, a company which has access to long term sources of bonds are not risk free. If the company which issued the bonds goes
funds may be able to declare dividends even if they are faced with bankrupt, the holder of the bonds will no longer receive any return from
investment opportunities. However these investment opportunities are their investment and even their principal investment can be wiped out.
generally financed by both debt and equity. - Equity Instruments generally have varied returns based on the
- The management usually appropriates a portion of retained earnings for performance of the issuing company. Returns from equity instruments come
investment undertakings and this may limit the amount of retained earnings from either dividends or stock price appreciation.
available for dividend declaration.
The following are types of equity instruments: (GSIS) and Social Security System (SSS), unit investment trust fund (UITF),
Preferred Stock has priority over a common stock in terms of claims over investment banks, and credit unions, among others.
the assets of a company. This means that if a company were to be liquidated
and its assets have to be distributed, no asset will be distributed to common
stockholders unless all the claims of the preferred stockholders have been
given.
Holders of Common Stock on the other hand are the real owners of the
company. If the companys growth is spurring, the common stockholders will
benefit on the growth. Moreover, during a profitable period for which a
company may decide to declare higher dividends, preferred stock will receive
a fixed dividend rate while common stockholders receive all the excess. Review of Financial Statement Preparation, Analysis, and Interpretation
Pt.1
2. Financial Markets
Brief introduction on learning objectives
Classify Financial Markets into comparative groups:
- Primary vs. Secondary Markets Learning Competencies The learners shall be able to prepare financial
To raise money, users of funds will go to a primary market to issue new statements (ABM_BF12-III-6)
securities (either debt or equity) through a public offering or a private
placement. Accounting is the systematic and comprehensive recording of financial
The sale of new securities to the general public is referred to as a public transactions pertaining to a business. (Investopedia - Sharper Insight.
offering and the first offering of stock is called an initial public offering. The Smarter Investing. | Investopedia. (2016). Investopedia. Retrieved 8 May
sale of new securities to one investor or a group of investors (institutional 2016, from http://investopedia.com) 1.
investors) is referred to as a private placement.
However, suppliers of funds or the holders of the securities may decide to The Accounting Equation The basic accounting equation is:
sell the securities that have previously been purchased. The sale of ASSETS = LIABILITIES + OWNERS EQUITY
previously owned securities takes place in secondary markets. The
Philippine Stock Exchange (PSE) is both a primary and secondary market. This means that the whole assets of the company comes from the liability,
or debt of the company, and from the capital of the owner of the business,
- MONEY MARKETS VS. CAPITAL MARKETS and the income it generated from the business operations. This reflects the
Money markets are a venue wherein securities with short-term maturities double-entry bookkeeping, and shown in the balance sheet.
(1 year or less) are sold. They are created because some individuals, Double entry bookkeeping tells us that if we add something from the one
businesses, governments, and financial institutions have temporarily idle side, which is asset, we must add the same amount to the other side to keep
funds that they wish to invest in a relatively safe, interest-bearing asset. At them in balance.
the same time, other individuals, businesses, governments, and financial For example, if we were to increase cash (an asset) we might have to
institutions find themselves in need of seasonal or temporary financing. increase note payable (a liability account) so that the basic accounting
equation remains in balance.
On the other hand, securities with longer-term maturities are sold in
Capital markets. The key capital market securities are bonds (long-term debt)
and both common stock and preferred stock (equity, or ownership).
3. Financial Institutions
Identify examples of financial institutions: - Commercial Banks - Individuals In double-entry bookkeeping, there is the concept of debit (dr) and credit
deposit funds at commercial banks, which use the deposited funds to provide (cr). Debit is the left, and credit is the right.
commercial loans to firms and personal loans to individuals, and purchase There is also a concept of normal balances. A normal balance, either a debit
debt securities issued by firms or government agencies. - Insurance normal balance or a credit normal balance, is the side where a specific
Companies - Individuals purchase insurance (life, property and casualty, and account increases.
health) protection with insurance premiums. The insurance companies pool In the accounting equation, asset is on the left side, while liabilities and
these payments and invest the proceeds in various securities until the funds equity is on the right side. Therefore, asset has a debit normal balance,
are needed to pay off claims by policyholders. Because they often own large meaning that cash as an asset is debited to increase, while credited to
blocks of a firms stocks or bonds, they frequently attempt to influence the decrease.
management of the firm to improve the firms performance, and ultimately, On the other hand, liabilities and owners equity have a credit normal
the performance of the securities they own. balance. This means that a liability account is credited to increase, while
debited to decrease. The accounting equation provides the foundation for
- Mutual Funds - Mutual funds are owned by investment companies which what eventually becomes the balance sheet.
enable small investors to enjoy the benefits of investing in a diversified
portfolio of securities purchased on their behalf by professional investment 2. T-Account Analysis In double-entry bookkeeping, the terms debit and
managers. When mutual funds use money from investors to invest in newly credit are used to identify which side of the ledger account an entry is to
issued debt or equity securities, they finance new investment by firms. be made. Debits are on the left side of the ledger and Credits are on the
Conversely, when they invest in debt or equity securities already held by right side of the ledger. It does not matter what type of account is
investors, they are transferring ownership of the securities among investors. involved.
Using the accounting equation, we can now expand the analysis that
will include both real and nominal accounts. All nominal accounts will
be then closed to a Retained Earnings account at the end of the period,
which is an owners equity account.
Illustrative Example:
Calvo Delivery Service is owned and operated by Noel Calvo. The
following selected transactions were completed by Calvo Delivery 4. The Accounting Cycle
Service during February: Because accounting is all about getting data and putting them into
A. Received cash from owner as additional investment, P35,000. the accounting equation, the end products are financial statements
B. Paid creditors on account, P1,800. such as a balance sheet and income statements, the process of
C. Billed customers for delivery services on account, P11,250. accounting follows a cycle called the Accounting Cycle.
D. Received cash from customers on account, P6,740. It starts with the identification of whether a transaction is
accountable or can be quantified, and ends with a post-closing trial
balance.
The Process:
Step 1: Analyze Business Transactions.
In this step, a transaction is analyzed to find out if it affects the
company and if it needs to be recorded.
Personal transactions of the owners and managers that do not affect
the company should not be recorded.
In this step, a decision may have to be made to identify if a
transaction needs to be recorded in special journals such as a sales or
3. Nominal Accounts purchases journal.
There are two major categories of nominal accounts: Expense and
Revenue accounts. Therefore, what you should do is:
Expense Accounts A. Carefully read the description of the transaction to determine
- A resource, when not yet used up for the current period, is whether an asset, a liability, an owners equity, a revenue, an expense,
considered an Asset and will provide benefits at a future time. - On the or a drawing account is affected.
other hand, a resource that has been used for the current period is B. For each account affected by the transaction, determine whether the
called an Expense. At the end of each accounting period, expenses are account increases or decreases.
closed out to the Retained Earnings Account which decreases the C. Determine whether each increase or decrease should be recorded as
Owners Equity. Since expenses decrease the owners equity, those a debit or a credit, following the rules of debit and credit.
expense accounts carry a normal debit balance.
Illustrative Example:
Revenue Accounts N. Juna resigned from Company X. This does not affect any asset,
- Revenue Accounts reflect the accumulation of potential additions to liability, or the owners equity account.
retained earnings during the current accounting period. B. Cano purchased PHP500 cash worth of supplies at Ace Hardware.
- At the end of the accounting period accumulation of revenues during This affects cash and supplies, both asset accounts.
the period are closed to the Retained Earnings Account which increases
Owners Equity. Step 2: Record This in the Journal.
- Therefore revenue accounts carry a normal credit balance meaning Using the rules of debit and credit, transactions are initially entered in
the same balance as the Retained Earnings Account. a record called a Journal and the entry made is called a Journal Entry.
The journal serves as a record of when transactions occurred and
Illustrative Example: were recorded.
J. F. Outz, M.D., has been a practicing cardiologist for three years. For repetitive transactions or high volume transactions (e.g. one
During April 2009, Outz completed the following transactions in her thousand sales transactions in one day), Special Journals are made.
practice of cardiology: These special journals include sales journal, purchases journal, cash
Mar 1 Provide medical services to clients for cash P35,000. receipts journal, and cash disbursements journal.
Mar 2 Paid rent for the month, P3,000.
Paid advertising expense, P1,800. Note: The Source Document is the file or document (i.e. official receipt,
Mar 6 Purchased office equipment on account, P12,300. purchase order, contract) that will provide a basis or reason for a
Mar 15 Paid creditor on account, P1,200. journal entry. For example, an official receipt issued by the business will
Mar 27 Paid cash for repairs to office equipment, P500. tell you that a sale transaction occurred and will be reflected by the
Mar 30 Paid telephone bill for the month, P180. journal entry.
Mar 31 Paid electricity bill for the month, P315.
Illustrative Example:
M. Jaya resigned from Company X. No journal entry.
C. Danto purchased PHP500 cash worth of supplies to Ace Hardware. The analysis and updating of accounts at the end of the period before
Debit Supplies PHP500, Credit Cash PHP500. the financial statements are prepared is called the Adjusting Process.
The journal entries that bring the accounts up to date at the end of the
Step 3: Post the Transactions on a Ledger. accounting period are called Adjusting Entries.
A transaction is first recorded in a journal. Periodically, the journal The following are normally adjusted at the end of a period: - Accruals.
entries are transferred to the accounts in the ledger. These include unpaid salaries for the accounting period, unpaid interest
The process of transferring the debits and credits from the journal expense, or unpaid utility expenses.
entries to the accounts is called Posting. - Prepayments. If a company has prepaid expenses such as prepaid rent
Ledgers provide chronological details as to how transactions affect or prepaid insurance then the correct balances for these accounts have
individual accounts. There are two types of ledgers: the General Ledger to be established at the end of each accounting period to reflect their
and Subsidiary Ledger. The general ledger is a summary of the different correct balances.
Subsidiary Ledgers and can serve as a control account. - Depreciation and amortization expenses. Depreciation expenses are
For example, a general ledger for accounts receivable summarizes the recognized at the end of each accounting period through adjusting
balances found in the different subsidiary ledgers for different entries. If there are intangible assets such as franchise, the allocation
customers. of their costs which is called amortization expense, is also recognized at
the end of each accounting period through adjusting entries.
Illustrative Example: - Allowance for uncollectible accounts. Bad debt expense from
J. Gaya, a CPA, is an independent auditor with only two clients. The accounts receivable is also recognized through adjusting entries.
Accounts Receivable ledger account has a balance of PHP100,000. His
two clients are A. Rania, and X. Campos. The subsidiary ledger of A. Step 6: Prepare an Adjusted Trial Balance.
Rania has a balance of PHP25,000. X. Camposs ledger balance is An adjusted trial balance is prepared after taking into consideration
PHP75,000. The sum of subsidiary ledgers must total the general ledger the effects of the adjusting entries. Again, this is to ensure that the
or else there must be an investigation to identify the source of total debit balances equal the credit balances after posting and
discrepancies. journalizing adjusting entries made.
Step 7: Prepare the nancial statements. From the adjusted trial
balance, the financial statements can then be prepared. These are the
statement of financial position, statement of profit or loss, and the
statement of cash flows.
Step 8: Make the closing entries. In the discussion about accounts, it
was discussed that nominal accounts (revenue and expense accounts)
are closed to retained earnings, or an owners capital account because
these accounts refer only to a specific accounting period. Actually,
these accounts to be closed are accounts that can be seen in the
income statement.
Posting in the subsidiary ledgers can be done anytime and the balances
Upon closing:
are summarized at the end of an accounting period. Posting in the
- If the revenues exceed expenses during an accounting period,
general ledger is done at the end of an accounting period.
retained earnings will increase.
- The reverse is true which means that if the expenses exceed revenues,
Step 4: Prepare an Unadjusted Trial Balance.
the retained earnings will decrease.
Errors may occur in posting debits and credits from the journal to the
In closing temporary accounts:
ledger. One way to detect such errors is by preparing a trial balance.
- Revenue account balances are transferred to an account called
Double-entry accounting requires that debits must always equal
Income Summary Account (sometimes profit or loss summary). -
credits. The trial balance verifies this equality.
Expense account balances are also transferred to the Income Summary
The steps in preparing a trial balance are as follows:
Account.
1. List the name of the company, the title of the trial balance, and the
- The balance of the Income Summary (net income or net loss) is
date the trial balance is prepared.
transferred to the owners capital account.
2. List the accounts from the ledger and enter their debit or credit
- The balance of the owners drawing account is transferred to the
balance in the Debit or Credit column of the trial balance.
owners capital account.
3. Total the Debit and Credit columns of the trial balance.
4. Verify that the total of the Debit column equals the total of the
Step 9: Make a Post-Closing Trial Balance.
Credit column.
A Post-Closing Trial Balance shows the accounts that are permanent or
real. These are the accounts that can be seen in your balance sheet.
Step 5: Make adjustments. Journalize adjusting entries.
The post-closing trial balance is prepared to test if the debit balances
At the end of the accounting period, many of the account balances in
equal the credit balances after closing entries are considered. 5. Basic
the ledger can be reported in the financial statements without change.
Financial Statements. A nancial statement is basically a summary of all
For example, the balances of the cash and land accounts are normally
transactions that are carefully recorded and transformed into
the amount reported on the balance sheet. However, some accounts in
meaningful information. It also shows the companys permanent and
the ledger require updating.
temporary accounts. Basically, financial statements are comprised of
This updating is required for the following reasons:
the following:
1. Some expenses are not recorded daily. For example, the daily use of
supplies would require many entries with small amounts. Also,
managers usually do not need to know the amount of supplies on hand
on a day-to-day basis.
2. Some revenues and expenses are earned as time passes rather than
as separate transactions. For example, rent received in advance
(unearned rent) expires and becomes revenue with the passage of
time. Likewise, prepaid insurance expires and becomes an expense with
the passage of time.
3. Some revenues and expenses may be unrecorded. For example, a
company may have provided services to customers that are has not
billed or recorded at the end of the accounting period. Likewise, a
company may not pay its employees until the next accounting period
even though the employees have earned their wages in the current
period.