Chapter 1: The Statement of Financial Position (SFP)

Learning Objectives

By the end of the chapter, the student should be able to:

1. Understand the purpose of the Statement of Financial Position (SFP);

2. Enumerate the basic elements of the Statement of Financial Position;
3. Describe the nature of the account reported on the Statement of Financial Position;
4. Prepare Statement of Financial Position using report format and account format;
5. Prepare a classified Statement of Financial Position; and
6. Determine the normal balances of the Statement of Financial Position accounts.

Assignment for Research

Download the 2013 Annual Report of Jollibee Food Corporation at the following link
http;//www.jollibee.com.ph/investors/financials/annual-reports/.

Jollibee Food Corporation (JFC) is the parent company of Jollibee, Red Ribbon, Chowking, Burger King,
and Mang Inasal. The annual report contains the 2013 Audited Financial Statements (FS) of JFC and
Subsidiaries. We will begin our tour of the JFC’s FS on page 35, the Statement of Management Responsibility.

The Statement of Management Responsibility informs us that the management of JFC is responsible
for the information content on the FS. They are at fault for any incorrect information on the FS. This is
written to prevent the wrong impression that the auditor who certifies the FS bears responsibility for its
content. And this brings us to page 36.

Page 36 shows the independent auditor’s report on the FS. It tells us the auditor’s opinion on the
fairness of the FS based on their audit. For now, let us consider fairness as correctness of the information in
accordance with generally accepted accounting standards. In this case, the accounting standard adopted by
JFC is Philippine Financial Reporting Standards. The auditor may say that the FS was presented fairly; not
presented fairly; presented fairly except for some specific issues; or the FS cannot be audited. An auditor’s
fair opinion gives credibility to the FS. Read the auditor’s opinion. What do you think are the limitations of
their audit?

Now we reach the highlight of this chapter (page 37). Page 37 contains the Statement of Financial
Position (SFP). Note that there is a column for 2013 and another column for 2012. This is the Comparative
FS. A comparative FS fives us the FS of the prior year side by side with that of the reporting year. What
insights can you gain from comparative information?

Let’s look at the 2013 column. JFC reported total assets of P46.1 Billion. Total liabilities stands at P
22.7 Billion and stockholders’ equity is P 23.4 Billion. Total liabilities and stockholders’ equity is equal to
total assets of P 46.1 Billion.

In this chapter, we will discuss assets, liabilities and equities – the elements of the Statement of
Financial Position. What are assets? What are liabilities and equity? Is it a coincidence that JFC’s total
liabilities and equities of P 46.1 Billion, is exactly equal to Jollibee’s total assets? Hopefully, by the end of
chapter1, you will have more appreciation of JFC’s Statement of Financial Position.

A Snapshot of the Financial Position

 We begin our study of financial statements with the Statement of Financial Position (SFP). It was
previously referred to as Balance Sheet. What is the origin of the name Balance Sheet? The Balance is
divided into two parts (figure 1). The assets are on one side and the claims are on the other side. Claims of
creditors are called liabilities while claims of owners are referred to as equity. The total of the assets should
equal the total of the claims. Hence, the statement was endearingly referred to as Balance Sheet because it
is a statement where the two parts must balance.

LIABILITIES
ASSETS
EQUITY
Figure 1: The Accounting Equation
At the topmost part of the SFP is the title. The first line of the title shows the name of the company.
It allows easy identification of the reporting entity. The second line identifies the FS which is the SFP. The
third line is the date of the SFP. It share “as of the year ended”. This differentiates the SFP from the other
financial statements with the third line of the title that reads “for the year ended.” How important is the
third line?
It tells the reader that the balances reported on the SFP is the net effect of all transactions related to the
specific account from the date of the establishment of the company up to the date of the SFT. As an example,
look at the SFP in Figure 2. How is the balance of cash of P 120,000 computed? It is simply the sum of cash
receipts less all the cash payment from the establishment date to the SFP cut-off date. What is the meaning
of the P 120,ooo cash balance? This is the amount of cash available to be used for the company’s operations
“as of” December 31, 20x1. In contrast, look again at Figure 2, but this time direct your attention to the
Statement of Comprehensive Income which has for its thirds line “for the year ended” December 31, 20x1.
Reported revenue (SoCE). SoCE is a report that presents the computation of the year end balance of equity
accounts that are reported in the Equity section of the SFP. The last statement is the Statement of that are
reported in the Equity section of the SFP. The last statement is the Statement of Cash Flows (SCF). This
statement explains the cash balance that is reported on the SFP. The interconnected reports eventually end
on the SFP.

Discussion Questions: Before moving on to the next part, answer the following review questions:

1. What is the other name for SFP?

2. Differentiate an “as-of” and “for the period” report.
3. Discuss how the other financial statements are linked to the SFP.

Elements of the Statement of Financial Position

The SFP is a report based on the accounting equation: Assets = Liabilities + (Owners’) Equity (Figure
1). Most students endearingly refer to the accounting equation as ALOE. It was once called a Balance Sheet
because the sum of the assets should be “balanced” as a consequence of double-entry accounting.

On one side of the SFP are assets. Assets are resources with future benefits that are within the
control of the company. The asset should be useful to the company in the future. Control means that the
company can prevent others from benefiting from the asset. To appreciate this, we will analyze how cash,
a known asset, met this definition.

Out analysis of cash begins with the future benefits criterion. What are the uses of cash? It can be
used to settle obligations, pay for purchases of assets or be distributed to owners. The second criterion is
control? Can control be exerted over cash? Physical safeguards and processes are established in order to
prevent others from using the company’s cash for themselves. Example of control is depositing cash in
reputable banks. Moreover, there are legal actions that the company can use against someone who steal
or misuse its cash. Given our analysis, cash is a resource that met the definition of an asset. Other examples
of assets are receivables, inventory and equipment.
 On the other side of the SFP are the claims. Liabilities and equity are sources of financing. Liabilities
are claims of creditors while equity represents claims of owners. Creditors require payment of principal and
interest. Owners, on the other hand, are not required to be repaid for their investment in the company. In
the event of the company’s closure, the owners are entitled to the assets of the company only after all the
creditors had been paid.

Discussion Questions: before moving to the next part, answer the following review questions:

4. what are the elements of the SFP?

5. what is an asset?

6. What is a liability? Differentiate liability from equity.

Assets

Recall that assets are resources with future benefits that are within the control of the company.
Resources are classified into asset accounts based on its future use to the company. There are many kinds
of assets. This book will focus only on the following assets.

1. Cash
2. Receivables
3. Inventory
4. Prepaid Expenses
5. Property, Plant, and Equipment
6. Intangible Assets

Cash
We will discuss the most well-known assets class first – Cash. Cash is money owned by the company.
Cash kept in the company’s premises is called cash on hand. Cash in bank refers to money in the bank which
can be kept in a savings or checking account. Generally, time deposit is not categorized as cash, this will be
further explained in detail below.

Strictly speaking, cash refers only to funds readily available to be spent for the company’s operations.
It is used for buying assets, paying suppliers, utilities, employee salaries and others. It is also used for
settlement of obligations. On the other hand, cash are sourced from contribution of owners, proceeds from
borrowings, sale of assets or collections from customers.

ABC Company
Statement of Comprehensive Income
For the year ended December 31, 20x1

Revenue P 1,290,000
Less: Expenses 890,000
Net Income 400,000

ABC Company
Statement of Changes in Equity
 For the year ended December 31, 20x1
Balance, January 1, 20x1 P 876,000
Add: Contributions during the year 200,000
Add: Net Income 400,000
Less: Drawings of owners 250,000
Balance, December 31, 20x1 1,226,000

ABC Company
Statement of Statement of Financial Position
As of December 31, 20x1

Cash P 120,000
Other current assets 570,000
Property, plant, and equipment 1,200,000
Total Assets 1,890,000

Currents liabilities 412,000

Long-term notes payable 252,000
Total liabilities 664,000

Owner, Capital 1,225,000

Total liabilities and equity 1,890,000

ABC Company
Statement of Cash Flows
For the year ended December 31, 20x1

Cash inflow from operating activities P 1,120,000

Cash outflow from investing activities
Cash inflow from financing activities
Net change in cash
Cash, January 1, 20x1
Cash, December 31, 20x1

Cash on hand includes bills, coins and bank checks kept in the premises of the company. Bank checks,
or checks, are bank documents used by the issuer to instruct the bank to pay the assigned payee from funds
in the issuer’s bank account. Checks maybe reported as part of cash because these documents are accepted
as payments and deposits. A check is classified as cash if the date of the check is on or before the SFP date.
A check dated after the SFP date is a post-dated check and is classified as receivable rather than cash.

Not all bank deposits are classified as cash. Some accounts are not readily available for use such as
a time deposit account. A time deposit account is a deposit in the bank that earns higher interest because
the depositor commits not to withdraw the funds over the agreed upon time. Penalties are imposed if the
depositor withdraws before the maturity of the deposit. Given the withdrawal restrictions, time deposits
are not classified as cash. Those with a term of up to 90 days are reported as cash equivalents while those
that will mature longer than 90 days are reported as investments.

Cash equivalents are technically not cash because it is not immediately available for use. It is almost
cash in the sense that it will become cash within the next 90 days. Time deposits with term maturities of
ninety days or less are examples of cash equivalents. It is generally reported on the SFP together with cash.
The line account is cash and cash equivalents. However, the components of cash and cash equivalents (cash
on hand, cash in bank cash equivalents) are required to be disclosed in the accompanying notes to financial
statement.

FRIENDLY CONVENIENCE STORE

Cash

1. She kept some cash in the store as changes funds (sukli). The cash count revealed 3 pieces of
100 peso bills, 5 pieces of 50 bills, 5 pieces of 20 peso bills, 5 pieces of 10 peso coins, 10 pieces
of 5 peso coins, 10 pieces of 1 peso coins and 25 pieces of 25 centavo coins.
2. Two of her regular customers gave Juan the following checks in payment of debts:
a. P 1,540 check dated December 31, 20x1.
b. P 2,432 check dated January 3, 20x2.
3. There are two bank accounts in the name of the store with the following balances:
a. Balance of the savings account on December 31, 20x1 according to the passbook is P 26,
780.
b. A time deposit certificate for P 100,000 for 90-days.

Report to Juan dela Cruz the balance of the cash and cash equivalents account of Friendly
Convenience Store.

ANSWER

Denomination Number of bills Peso Amount

P 100 3 P 300.00
P 50 5 250.00
P 20 5 100.00
P 10 (coins) 5 50.00
P 5 (coins) 10 50.00
P 1 (coins) 10 10.00
P 0.25 (coins) 25 6.25
Total cash on hand P 2,306.25
Cash in bank 26,780.00
Total cash 29,086.25
Cash equivalents 100,000.00
Total Cash and Cash Equivalents 129,086.25

NOTES:
1. The P 2,432 check dated January 3, 20x2 is a post –dated check. It is not cash as of December
31, 20x1.
2. The time deposit certificate for P 100,000 for 90-days will no meet the definition of cash. It is
classified as cash equivalents.

Receivables

Receivables is a general term that refers to the company’s right to collect or claim payment. The
right to collect comes from unpaid sales or lending activities. Generally, the company collects cash from its
receivables. There are also receivables that may be settled in other assets or services. For example,
receivable from suppliers may be settled in merchandise.

A sale agreement may require a customer to pay the seller immediately upon delivery of goods. This
is called cash on delivery (COD). In contrast to COD, a customer may instead promise to pay the seller at
some future time after delivery. This is a credit sales agreement and it give rise to Account Receivable.
Normally referred to as AR, this account means receivable from customers. It is evidenced by sales invoices
and delivery receipts. Accounts receivable normally has a term of 30 days which means a customer should
pay 30 days from date of delivery. Some sellers are more lenient and give terms of 60, 90 and 180 days.

Notes receivable is another kind of receivable. It is evidenced by promissory notes (PN). PN is a legal
document that says the borrower promises to pay, on scheduled payment dates, a specific sum called the
principal and interest based on principal and stated interest rate. Customers who are unable to pay their
accounts on due dates are sometimes required to sign a PN. The company may also lend money to its
employees or other companies if the company has excess cash.

FRIENDLY CONVENIENCE STORE

Accounts Receivable

Juana asked you to compute how much Marie Reyes owned the store. Juan sells to Maria on credit.
Maria pays every 15th and 30th of the month. Maria’s listings are reproduced below:

Maria Reyes
Balance P 124.00
Sept. 5 2 bottles of cola (P 12 each)
Sept. 15 1 bar of laundry soap (P 50)
October 3 1 sachet of fabric softener (P 50)
October 8 1 small can of sardines (P 25)
October 15 Payment P 200.00
October 25 2 bag of chips (P 30 each)
October 30 Payment P 100.00
November 16 1 sachet of laundry soap (P 50)
November 22 2 kilo of rice (P 44 per kilo)
November 30 Payment P 100.00
December 1 5 sachets of shampoo (P 15)
December 15 Payment P 100.00
December 22 1 small can of sardines (P 25)
December 27 2 kilo of rice (P 44)
December 28 1 small bar of bath soap (P 20)
December 29 5 sachets of shampoo (P 15)
December 30 Payment: P 100.00

ANSWER
Maria Reyes
Balance P 124.00 P 124.00
Sept. 5 2 bottles of cola (P 12 each) 24.00
Sept. 15 1 bar of laundry soap (P 50) 50.00
October 3 1 sachet of fabric softener (P 50) 50.00
October 8 1 small can of sardines (P 25) 25.00
October 15 Payment P 200.00 (200.00)
October 25 2 bag of chips (P 30 each) 60.00
October 30 Payment P 100.00 (100.00)
November 16 1 sachet of laundry soap (P 50) 50.00
November 22 2 kilo of rice (P 44 per kilo) 88.00
November 30 Payment P 100.00 (100.00)
December 1 5 sachets of shampoo (P 15) 75.00
 December 15 Payment P 100.00 (100.00)
December 22 1 small can of sardines (P 25) 25.00
December 27 2 kilo of rice (P 44) 88.00
December 28 1 small bar of bath soap (P 20) 20.00
December 29 5 sachets of shampoo (P 15) 75.00
December 30 Payment: P 100.00 (100.00)
Net Receivable P 154.00

Inventory

The Inventory account reports the cost of unsold merchandise. The Inventory account of a trading
business contains merchandise held for resale. A manufacturing company will have more complex
inventories composed of raw materials, unfinished inventories in the middle of the manufacturing process
(may also be called work in process ), and unsold finished goods.

Consignment is an important issue in inventory accounting. The owner places his goods “on-
consignment” in the premises of the store owner. The store is not obligated to purchase the goods. The
owner may also withdraw his unsold goods from the store at any time. The store owner, on the other hand;
will remit to the merchandise owner the proceeds from the sale of the consigned items. The store owner’s
income from this transaction maybe in the form of commissions from the sale and/or rent from the store
space used to display the consigned goods. The store should not report the consigned goods as inventory
even if they are held in the store premises. Rather, the consigned merchandise will be reported as inventory
by the merchandise owner.

Only merchandise held for sale are reported as inventory. Those items that are to be used in the day
to day activities of the company are supplies and not inventory. For example, a convenience store sells
ballpoint pens. The owner also uses ballpoint pens in recording transactions in the store’s accounting
records. By definition, only those ballpoint pens for reselling are reported as inventory. Those that are to be
used in the business are classified as supplies.

FRIENDLY CONVENIENCE STORE

Inventory
Before Juana opened the store on January 1, 20X2, she asked you to help her count the merchandise inside
the store. The result of the count are given below:

Merchandise Cost
2 bags of candy P30 per bag
10 sachets of coffee P6 per sachet
10 sachets of laundry powder P15 per sachet
1 sack of rice P1,800 per sack
10 cans of sardines P15 per can
10 chocolate bars P20 per bar
5 notebooks P25 per notebook
Note:
1. The chocolate bars were on consignment from Tsokolate-Eh.
2. Of the 5 notebooks inside the store, one is used for listings of customer credit.
3. Report to Juana Dela Cruz the balance of the merchandise inventory account of Friendly Convenience Store.
 ANSWER

Merchandise Cost Total

2 bags of candy P30 per bag P60.00
10 sachets of coffee P6 per sachet P60.00
10 sachets of laundry powder P15 per sachet P150.00
1 sack of rice (50 kilos) P1,800 per sack P1, 800.00
10 cans of sardines P15 per can P150.00
4 notebooks (see number 2 below) P25 per notebook P100.00
Merchandise Inventory as of December 31, 20X1. P2,320.00

Note:
1. The chocolate bars are not allowed by the store. It was on consignment from Tsokolate-Eh.
2. Only 4 notebooks were for sale. One was used as office supplies in the store.

Prepaid Expenses

Prepaid Expenses refer to future expenses that the company had paid for in advance. It is placed in
this account until the services or items are used and become expenses. Recall back the concept of accrual
discussed in Fundamentals of Accountancy, Business and Management 1. Expenses are recorded only when
purchased goods and services are used.

Let us look at mobile phone services. When prepaid subscribers purchase “loads” or “cards”, they
essentially pay the phone companies prior to using their services. On the other hand, post-paid subscribers
pay only after they are billed for the services used. Accrual accounting dictates that expense is recognized
only when phone services are used, regardless of whether they are prepaid or post-paid subscribers. The
question now is how prepaid subscribers account for their load or card purchases. It is parked in the Prepaid
Expense account. When the load is consumed, the cost of the card is transferred out of Prepaid Expense into
Communications Expense.

Another kind of prepaid expense is insurance. The insured will pay premium at the beginning of the
contract period and the insurer (insurance company) will reimburse the insured party for losses if the insured
event occur. For example, an annual fire insurance contract requires the insured party to pay premium at
the beginning of the contract year. During the contract period, if fire occurs at the insured premises, then
the insurance company will pay the insured for the amount of damages he suffered resulting from the fire.
However, the insurance company had no obligation to return the premiums paid by the insured party if there
is no fire during the contract period. So, why do companies buy insurance contracts? It is because the
premium payments are significantly lower than the amount of the estimated damages that the company will
burden if the insured event indeed occurs. A company buys insurance contract to be prepared in case
something happens, even if they hope that thing never happens.

Insurance contracts are time based. The buyer of the contract is insured only within the contract
period. This means that the advanced payment of the insured is at first a Prepaid Expense. It is transferred
to expense evenly over the contract period. Also, at the end of the contract period, the entire advance
payment should have been fully transferred to expense such that the balance of the Prepaid Insurance is
zero.
 Friendly Convenience Store: Prepayments
Juana paid premium of P2, 500.00 for one-year fire insurance in the name of the store on October 1, 20X1.
How much should prepaid insurance be on December 31, 20X1?
Answer
Insurance premium is paid in advanced. In the case of the Friendly Convenience Store, the P2, 500.00
premium payment was for insurance from October 1, 20X1 to September 30, 20X2.
As of December 31, 20X1, three months had already passed and considered expense. Therefore, only nine
months is Prepaid Expense.

We compute the Prepaid Insurance Expense as P2, 500.00 * 9/12 = P1, 875.00

Property, Plant, and Equipment

Property, Plant, and Equipment or PPE for short, are long-term assets that are used in the operations
of the company. These are classified as long-term asset (or non-current asset) because these assets will be
used in the business for more than one year. Examples of such assets classified as PPE are land, building,
warehouse, automobiles, delivery vehicle, computer equipment and manufacturing equipment. Only those
assets owned and controlled by the company will be reported as PPE. Rented facilities and equipment are
excluded from PPE.

Recall that assets are resources with future benefits for the company. For PPE, such benefits are to
be used for more than one year. The cost of purchasing PPE is not immediately reported as expense, rather,
it is recognized as asset. As the asset is used, a portion of the cost is transferred to the expense. The process
of recognizing the asset is called capitalization while depreciation refers to transferring of cost of asset to
expense. Depreciation is linked to usage. It seems necessary to estimate the pattern of usage in order to
compute for depreciation. To simplify, it is an acceptable assumption in accounting that the asset will be
used evenly over its life. This is the straight-lined method of depreciation. The depreciation will increase the
expense account and decrease the asset account. It is normal accounting practice not to directly decrease
the PPE account. Rather, a contra-asset account called accumulated depreciation is used to catch the
depreciation and decrease the asset value to be reported in the SFP. The cost of the PPE, net of the balance
of accumulated depreciation as of the SFP date is called Net Book Value of the PPE.

Not all PPEs are subject to depreciation. Land is not depreciated because this asset does not have a
useful life. More so, the value of land increases with the passage of time.

Friendly Convenience Store: Property, Plant, and Equipment

On January 1, 20X0, Juana purchased an electronic cash register to be used in the Friendly Convenience
Store. The cash register was purchased at a cost of P15, 000.00. Juana depreciated the cash register over
five years. Determine the following:
1. Equipment
2. Annual depreciation
3. Accumulated depreciation as of December 31, 20X1
4. Net book value of Equipment as of December 31, 20X1

Answer
 Cost of electronic cash register P15, 000.00 (1)
Estimated useful life (in years) 5
Annual depreciation (P15, 000.00/5 years) P3, 000.00 (2)
Number of years depreciated (20X0-20X1) 2
Accumulated depreciation P6, 000.00 (3)
Net book value (P15, 000.00 – P6, 000.00) P9, 000.00 (4)

Intangible Assets

Intangible assets are long-term assets similar to PPE. These assets will be used in the business for
more than one year. The allocation of the cost intangible assets to the year it was used is called amortization.
It is computed similar to depreciation such the cost of the asset is amortized evenly over its useful life. The
main difference between the two assets is that intangible assets have no tangible properties. These are
assets that you cannot see or touch. There may be a piece of paper as evidence of the asset but the actual
asset is “intangible”. Some examples of Intangible Assets are patent, brad name and trademark. A patent is
a brand conferred by the government to the creator of the invention, whether a product or a process, for
the sole right to make, use and sell that invention for a specified period of time. In recent years, the patent
infringement cases between Samsung and Apple filled the business news. Brand-name refers to word or
words used to identify a specific product or manufacturer. Famous brands include Jollibee, McDonalds,
Apples, Coca Cola, Samsung, Sony, and Nike. Trademark is the symbol that represents the brand. Take the
case of the happy red bee that represents Jollibee, the tall clown in stripes of McDonalds, and the swoosh
check mark or Nike.

Discussion Questions: Before moving on to the next part, identify the assets described below:
1. Money in the bank or money in the premises.
2. Asset that can be used in the company’s business over many years.
3. Unsold goods that were purchased to be sold to the company’s customers.
4. The company’s right to claim payments as evidenced by a promissory note signed by the debtor.
5. The company’s right to collect from the customer because delivery of goods and services have
been completed.
6. Advance payments for expenses such as cellphone loads.
7. A class of PPE that is not subject to depreciation.

Liabilities

We begin our study of the right side of the SFP with the liabilities. These are obligations that the
company is required to pay. Payment for liabilities may be in cash, goods, or services. Entities to whom the
company is indebted are called creditors. There are many different kinds of liabilities. This book will focus
on payables, accrued expenses, unearned income and long-term liabilities.

Payables

The opposite of right to collect is the obligation to pay. Receivables are right to collect payments
from debtors while payables are obligations to make payment to creditors. There are generally two kinds of
payables – Accounts Payable (AP) and Notes Payable (NP). AP normally refers to obligation to the suppliers
of inventories. It is evidenced by the supplier’s sales invoices and delivery receipts. Most suppliers give
credit terms of 30 to 90 days. A 30 day credit term means that the company should pay for the purchases
30 days from the date of delivery. Some suppliers give discounts for early payments. The credit term 2/10,
n/30 (reads: two ten net thirty) means payment of full amount is due in 30 days but a 2% discount may be
taken if paid within ten days (after delivery). This kinds of credit term encourages debtors to pay earlier than
their due dates.

NP refers to an obligation evidenced by a promissory note. Recall from our discussion of Notes
Receivable (NR). Promissory note (PN) is a document that expresses the borrower’s promise to pay. The
issuer of the promissory note reports this as NP in his accounting books. On the other hand, the holder of
the promissory note has the right to collect and reports NR in his accounting books.

Friendly Convenience Store:

Accounts Payable
On November 15, 20x1, Juan dela Cruz purchased five sacks of rice at P 1,800 per sack. The
credit term is 2/10, n/30. Determine how much Juana should pay given the following payment dates:
1. November 25, 20x1
2. December 15, 20x1

Answer
1. If Juana will pay anytime from November 15, 20x1 to November 25, 20x1, payment due
is:
Full cost of one sack of rice P 1,800
Number of sacks purchased 5
Total cost of purchased 9,000
Discount in % 2%
Discount in Peso 180
Discounted cost to be paid P 8,820

2. If Juana will pay after November 25, 20x1, she is liable for the full cost of P 9,000. She
will forego the savings of P 180.

Friendly Convenience Store:

Notes Payable
1. Promise to Pay. For value received. Friendly Convenience Ste, represented by Juan dela
Cruz, the manager, (Borrower) promises to pay United Bank (Lender) P 25,000 (Twenty five
thousand pesos) and interest at the yearly rate of 6% on the unpaid balance as specified
below.
2. Installments. Borrower will pay five payments of P 5,000 each at monthly intervals on the
30th day of the month. First payment is due on November 30, 20x1.
3. Application of Payments. Payments will be applied first to interest and then to principal.
4. Prepayment. Borrower may prepay all or any part of the principal without penalty.
5. Loan Acceleration. If Borrower is more than five days late in making any payment. Lender
may declare that the entire balance of unpaid principal is due immediately, together with the
interest that has accrued.

Answer the following questions:

1. Who will record the Note Payables?
2. Who will record the Notes Receivable?
3. Compute for the payment due on November 30, 20x1 and December 30, 20x1.
4. Determine the balance of Notes Payable as of December 31, 20x1.
 Answer
1. According to the PN, the borrower is Friendly Convenience Store. A Note Payable will be reflected
on the SFP of the store.
2. According to the PN, the lender is United Bank. A Note Receivable will be reflected on the SFP of
the bank.
3. Payment due on the following dates:
November 30, 20x1 December 30, 20x1
Unpaid balance, beginning P25, 000 P20, 000
Stated interest 6% 6%
Interest period* 1/12 1/12
Interest to be paid 125 100
Monthly principal payment 5, 000 5, 000
Payment due P5, 125 P5, 100

*Stated interest of 6% is expressed on a per annum basis. Simply put, it means 6% per 12 months
period. To get interest for one month, it’s 6%/12 months.

4. The balance of the Note Payable on December 31, 20X1 is P15, 000. Following the payment
schedule, Juana should have already made two payments of P15, 000 each as of December 31.
Hence, the remaining unpaid balance is (P25, 000-P10, 000) P15, 000.

Accrued Expenses

Let us recall our earlier discussion about prepaid mobile phone loads and post-paid plans. Mobile
phone loads are advance payments for future usage of mobile phone services. On the other hand, post-paid
service subscribers are billed for their usage of the service. The billing statement also states when payment
is due. Post-paid service plans are accounted for as Accrued Payment until payment is made to phone
company.

Accrued Expense refers to the unpaid expenses of the company as of cut-off date of the Statement
of Financial Position. There are many kinds of accrued expenses such as salaries payable, utilities payable,
rent payable and interest payable. Take the case of the following payroll schedule. Employees are paid every
15th and 30th day of the month. Salary paid on the 15th is for the work rendered by the employees for the
29th day of the current month to 13th day of the following month while that paid on the 30th is for work
rendered for 14th to 28th day of the same month. As of December 31 (calendar year SFP), the company would
have owed the employees for three days of week, December 29-31. According to the payroll schedule, these
days would be paid as part of their January 15 payroll. Therefore, salaries payable should reflect three days
of unpaid salaries.

Friendly Convenience Store: Accrued Expense

Juana hired Elena Reyes as storekeeper with salary of P400 per day. Elena is paid every Saturday for work
rendered during the week. Sunday is her day-off. December 31, 20X1 falls on a Thursday. Determine the
balance of salaries payable to be reported on the store’s SFP as of December 31, 20X1.

Answer
 Daily salary rate P400
Number of unpaid days (Monday to Thursday) 4
Salaries payable, December 31, 20X1 P1, 600

Unearned Income

Customer deposits or downpayments are customer payments received before the delivery of goods
or services. These will not account as sales until deliveries are made. These payments are initially recorded
as unearned income – liability payable in goods or services.

Take the case of a tailor of custom-made suits. He requires his customer to pay a downpayment upon
ordering. The tailor does this because (1) the money received from the customer will be spent on materials
for the suits; and (2) the significant payment made by the customer will ensure that he will return to claim
his order and pay the full price. Can the tailor record revenue based on the amount of downpayment
received from the customer? The answer is no. he can only record revenue when the suits are delivered to
and accepted by the customer. While these activities are not yet done, the cash received from the customer
is reported as unearned income. Upon delivery and acceptance, the unearned income is transferred to
revenue.

Unearned income is a liability. However, unlike regular liability, the settlement of unearned income
is not through direct cash payments to the customer. Rather, it is settled by the delivery of goods or
rendering services. The settlement of this liability is dependent on the contractual agreement between the
seller and the buyer. In the case of the tailor, it is job based. However, some contracts are time based. An
examples of this is advance rent.

Friendly Convenience Store: Unearned Income

Pedro Benitez, a neighbour of Juana, operates a coffee vending machine business. On October 1 20X1, he
entered in a contract with Juana to rent a small space on the counter-top of the store where he can put
his coffee vending machine. The rent is P500 per month. Pedro paid six months advance rent on October
1, 20X1. How much should be reflected as unearned rent income on the store’s SFP as of December 31,
20X1?

Answer

Monthly rental rate P500

Remaining unused months (January to March) 3
Unearned rent income, December 31, 20X1 P1, 500

Long-Term Liabilities

Long-term liabilities refer to the obligations with due dates that fall more than one year from the
date of SFP. Bank loan is a common example. It is documented by a promissory note. The company pays
interest periodically. The repayment of the principal is based on the contractual agreement. It can all be paid
at maturity or in instalment over the term of the loan. Long-term liability is part of the financing activities of
the company.
 Friendly Convenience Store: Prepayments
In order to construct the store, Juana borrowed P50, 000 from Universal Bank and P25, 000 from United
Bank. Terms of the loans are of follows:
Universal Bank: the bank requires Juana to pay interest of 7% payable monthly. The principal is payable
on October 1, 20X3.
United Bank: the bank requires Juana to pay five monthly instalments of P5, 000 plus interest in the unpaid
balance. The loan was taken on November 1, 20X1 and first monthly instalment is due on November 30,
20X1.
Which of the two loans should be reported as long-term liability on the store’s calendar 20X1 SFP?
Answer
1. While interest is payable monthly, the principal on the Universal Bank is payable on October 1,
20X3. The due date is one year and ten months from the date of the Statement of Financial Position
December 31, 20X1. This loan is classified as long-term liability because due date is beyond one
year of SFP.
2. Given the monthly principal payments, the United Bank loan will be fully paid by the end of March
20X2. This is only three months from the SFP date of December 31, 20X1. Hence, the United Bank
loan is a current liability. It may be reported as a note payable.

Discussion Questions: Before moving on to the next part, identify the name of the liability that matches
the description below:
1. Obligations payable after one year.
2. Obligations to pay suppliers of merchandise inventory.
3. Unpaid expenses such as utilities and salaries.
4. Liabilities supported by a legal document that promises to pay a specific amount to the creditor.
5. Cash deposit received from the customers.

Equity

Equity is the net assets if the business. It is composed of the owner’s investments and the
accumulated net income of the company, net of any distributions to the owners. It reflects the portion of
the asset that belongs to the owners of the business.

For a sole proprietorship, the SFP will only reflect one equity account – owner’s capital. This one line
account reflects all transactions of the business with its owner in his capacity as the owner. This account will
reflect the balance of the owner’s investments in the business such as cash contributions. The net income
earned by the company is also closed to the capital account. While a separate drawings account may be
maintained to follow the withdrawals of the owners during the year, this too is closed to the capital account
at the end of the year. We will visit this concept again in Chapter 3, Statement of Changes in Equity.

Presentation of Statement of Financial Position

There are two acceptable format of the SFP – the account form and the report form. The account
form mimics the general ledger T-account format. The assets are reported on the left and the list of liabilities
and equity are on the right.
In the account format, the total assets and total liabilities and equity are shown side by side to highlight that
both totals are equal.
 Assets Liabilities and Equity
Cash xxx Accounts payable xxx
Account receivable xxx Accrued expenses xxx
inventory xxx Unearned income xxx
Prepaid expenses xxx Notes payable xxx
Notes receivable xxx Long-term payable xxx
Property, Plant, and Equipment xxx
Intangible assets xxx Owner, Capital xxx
Total assets xxx Total liabilities and equity xxx
Figure 3: Statement of Financial Position Account Form

On the other hand, the report from SFP is a simple list. All the assets are listed first, followed by the
liabilities and finally the equity account.

Assets
Cash xxx
Account receivable xxx
inventory xxx
Prepaid expenses xxx
Notes receivable xxx
Property, Plant, and Equipment xxx
Intangible assets xxx
Total assets xxx

Liabilities and Equity

Accounts payable xxx
Accrued expenses xxx
Unearned income xxx
Notes payable xxx
Long-term payable xxx
Total liabilities
Owner, Capital xxx
Total liabilities and equity xxx

A modification of this statement is called the classified Statement of Financial Position. This means
that assets and liabilities are classified as to current or non-current. On the asset side, assets are classified
as current if it can be used or converted to cash within one year. Examples of current assets are cash,
accounts receivable and inventory. Prepaid expenses may be classified as current if the advance payment is
expected to be used within one year. The classification of notes receivable is dependent on the term of the
payments on the promissory note. The payments collectible within one year are classified as current. Those
collectible after one year are reported as non-current. Property, plant and equipment and intangible assets
are classified as non-current given their long-term nature.

Liabilities may also be classified in similar terms. Current liabilities are payables due to be paid within
one year of the SFP date. Examples of current liabilities are accounts payable and accrued expenses.
Unearned income is current if the delivery goods or services for the settlement of the advance payment is
to be made within one year. Similar to notes receivable, the classification of notes payable is dependent on
the terms of payment on the promissory note. Long-term liabilities are generally classified as non-current. If
the long-term liability is to be settled in instalments, then those scheduled to be paid within twelve months
are classified as current and referred to as current portion of long-term debt. The remaining instalments are
reported as non-current.

A classified SFP is helpful to the readers of the SFP. Current liabilities are those obligations that are
coming due in the next twelve months. As a result, the readers are interested to determine of the company
has sufficient current assets to afford the payment of the liabilities on their scheduled date.

Assets
Cash xxx
Account receivable xxx
inventory xxx
Prepaid expenses xxx
Notes receivable xxx
Total current assets xxx
Property, Plant, and Equipment xxx
Intangible assets xxx
Total non-current assets xxx
Total assets xxx

Liabilities and Equity

Accounts payable xxx
Accrued expenses xxx
Unearned income xxx
Notes payable xxx
Current portion of long-term debt xxx
Total current liabilities xxx
Long-term payable xxx
Total liabilities xxx
Owner, Capital xxx
Total liabilities and equity xxx

Figure 5: classified SFP

Normal Balances

Account Name
Debit Credit

Figure 6: General Ledger T-Account Format

Account Name
Account Number
Date Particulars Debit Credit Balance

Figure 7: General Ledger Account Format

 Recall the account form of Statement of Financial Account in Figure 3. It is called the accountform
because its format was based on the general ledger T-account (figure 6). The T-account format is not used
in actual business but is a very effective tool in teaching accounting. The actual format of a general ledger
account is in Figure 7.

Debit and credit refers to the sides of the T-account (Figure 6). A debit entry means that the amount should
be placed on left side of the T-account. A credit entry means that the amount should be placed on the right
side of the T-account.

Figures 3 and 6 are reproduced in Figure 8. Look at the account format of the SFP. Asset is on the left side,
the same side as debit is on the T-account. Combining these two together, the normal balance of asset
accounts is debit. Following this rule, then the normal balance of liability and equity accounts is credit. It is
because both are on the right side of the SFP, the same side as the credit on the T-account.

Assets Liabilities and Equity

Cash P xxxx Accounts payable P xxxx

Account receivable Xxxx Accrued expenses xxxx
Inventory Xxxx Unearned expenses xxxx
Prepaid expenses Xxxx Notes payable xxxx
Notes receivable Xxxx Long-term payable Xxxx
Property, plant, and equipment Xxxx
Intangible assets Xxxx Owner, Capital xxxx
Total assets P xxxxx Total liabilities and equity P xxxxx

Account Name

Debit Credit
Figure 8: Account Form SFP vis-à-vis T-Account

Why is it important to know the normal balances of each account? An account is increased by an
entry on the side of its normal balance. Similarly, it is decreased by an entry on the opposite e side of its
normal balance. For example, an asset account has a beginning balance of P 1,000. Assets have debit normal
balances, therefore, the beginning balance is on the debit side. During the year, the total debit and credit
entries amount to P900 and P 990, respectively. This asset account will have an ending balance of P 910
(Figure 9).

Asset Account

-
Beg. Balance P xxxx

+
Ending Balance-Beg. Balance+Debit-Credit
Asset Account
Beg. Balance P 1,000
900 900
1,900 990
Ending Balance P 910
 Figure 9: Analysis of Asset Account using a T-Account

For the next example, assume the same beginning balance as well as the same debit and credit entries
made during the year. However, the account is a liability instead of an asset. Recall that the normal balance
of a liability account is credit. Hence, the beginning balance should be o the credit entries will increase this
account. As a result, this liability account will have an ending balance of P 1,090 (Figure 10).

-
Liability and Equity Accounts
Beg. Balance P xxxx

+
Ending Balance-Beg. Balance+Credits-Debits
Liability and Equity Accounts
Beg. Balance P 1,000
900 990
900 1,990
Ending Balance P 1,090

Figure 10: Analysis of Asset Account using a T-Account

In summary, asset account have debit normal balances and are thus increased by debits. Liability
and equity accounts have credit normal balances and are thus increased by credits.

Discussion Questions: Before moving on to the next part, answer the following questions:
19. What are the two common formats of the SFP?
20. What is the SFP format that presents assets on to the left and liabilities and equity on the right?
21. What is the normal balance of an asset account?
22. What is the normal balance of a liability account?
23. What is the normal balance of an equity account?

Comprehensive Illustrative Problem: Mira’s Store

On February 1, 20a4, Mira Delamar opened a store that sell s school supplies. Her main customers
are the students and teachers of Happy Students School that is situated in front of her store. Mira wanted
to know the financial position of Mira’s Store. Mira knew you were studying accounting so she asked for
your help.

The following information were made available to you:

1. To start her business, Mira opened a checking account in the name of Mira’s Store. The statement
of account from the bank shown that the checking account has a balance of P 31,535 as of December
31, 20a4.
2. Mira told you that she keeps P 1,000, in small bills and coins, in her store which she uses as a change
(sukli) fund.
3. As of December 31, 20a4, cash on hand from sales and collections for the day amounted to P 12,000.
This does not include Mira’s change fund.
4. Mira showed you a delivery receipt for P 575. The receipt dated December 29, 20a4 showed that
manila papers and color markers were delivered to a Ms. Rebecca Di who is a grade school teacher
in Happy Students School. Ms. Di noted on the delivery receipt that she will pay Mira on January 15,
20a5.
 5. Mira’s Store is located on the ground floor of a commercial building. The commercial unit costs her
P 5,000 per month for rent. As of December 31, 20a4, Mira’s store has a remaining one month
advance rent with the landlord.
6. Mira purchased shelves and cabinets amounting P 30,000 to be used as display racks and storage fro
her store. The shelves and cabinets are expected to be used in the store for 5 years. Mira started
using the shelves and cabinets on December 1, 20a4.
7. After closing the store on December 31, 20a4, Mira counted all the unsold merchandise inside the
store. Mira does not have any other storage space except for the store premises. Based on Mira’s
count, the remaining unsold merchandise costs P 15,345.
8. Mira showed you a folder where she kept her unpaid receipts and bills. You noted the following:
a. A sales invoice dated December 25, 20a4 from Long Lasting Ballpoint Pens incorporated
amounting to P 2,645. The invoice term is 30 days.
b. A sales invoice from Papier Paper Company dated December 15, 20a4 for P 5,465. The payment
terms on the invoice is 40 days.
c. A Meralco bill for electricity consumption from December 1-31 for P 3,400. The bill is payable on
January 15,20a5.
d. February PLDT bill for P 600. The bill is payable on January 17, 20a5.
e. Mira hired Emily to help her inside the store. Emily’s salary is P 500/day. Emily’s wages were
paid on December 30, 20a4 for work rendered until December 29. Her pay for December 30 and
31 will be included in her January wages.
9. Mira showed you an official receipt for P 1,395. She told you that this is a downpayment from Ms.
Benny Ling, a grade 5 teacher in Happy Students School. Ms. Ling ordered green, red, and blue poster
paints for her students. The total price of the order was P 2,790. According to their agreement, Mira
will deliver the paints on January 3, 20a5.
10. On December 30, 20a4, Mira borrowed P 23,000 from her bank. She took advantage of the bank’s
special terms for small entrepreneurs. She signed a promissory note for her loan. The principal is
payable on December 30, 20a6. The interest is payable monthly beginning January 31, 20a5.
11. Mira started her business by depositing P 30,000 to open the checking account. On October 15, 20a4,
the business is in need of additional cash so Mira deposited P 5,000 to the checking account. Mira
also withdrew P 15,000 from the business over the year.

Requirements:
1. Prepare a classified Statement of Financial position for Mira’s Store as of December 31, 20a4.
2. Determine net income for the month-ended December 31, 20a4.

Solution:

1. It is necessary to determine the components of the SFP based on the data given in the problem. Belis
an analysis of each information given in the problem:
No. SFP Element>
Analsysis Account Name
Classification
1 Mira opened a checking account to be sued for the Asset> current Cash in bank is to be
operations of her business. presented as part of Cash
2 Mira maintain a change fund in the store. The small bills and Asset> current Cash in the change fund are
coins will allow Mira to give change to her customer and not still used in operation of the
inconvenience them by always asking for exact payment. business. Hence, this is
reported as part of Cash.
3 Undeposited cash from sales and collections are cash on Asset> current Cash on hand is reported as
hand part of Cash.
4 Mira has a right to collect payment from Ms. Di as a result Asset> current Right to collect from
of the delivery of the school supplies. Ms. DI even customers are reported as
acknowledges that she will pay on January 15. Account Receivable
5 As of December 31, Mira’s store has one-month advance Asset> current Prepaid Expense/Prepaid
rent. Rent
6 The cabinet and shelves are to be used in Mira’s Store as Asset> Property, Plant, and
display racks and storage. Moreover, these have useful life Non-current Equipment
of beyond one year, specifically five years. Hence, the cost
of the whole set should be reported as Property, Plant, and
Equipment
6 The estimated useful life of the cabinet and shelves is 5 Contra-Asset> Accumulated Depreciation
years. Mira’s Store had been using these assets for one Non-current
month. Hence, one month of depreciation should be
reported in accumulated depreciation.
7 The cost of the unsold merchandise held for sale in Mira’s Asset> Current Inventory
business is reported as inventory.
8a Obligations to suppliers for unpaid purchases of Liabilities> Accounts Payable
& merchandise are reported as Accounts Payable. Mira owes Current
8b money to two suppliers, Long Lasting Ballpoint Pens and
Papier Paper Company.
8c Meralco is the provider of electricity. PLDT provides the Liabilities> Accrued Expense
& telephone service. The unpaid bills from Meralco and PLDT Current
8d are considered Utilities Payable and may be reported as
Accrued Expense
8e The liability to Emily pertains to her unpaid wages as helper Liabilities> Accrued Expense
in the store. This is Salaries Payable under Accrued Current
Expenses
9 The advance payment of Benny Ling is for an unserved Liabilities> Unearned Income
order. Hence, this is not yet considered revenue. This Current
should be reported as Unearned Income. Also, only the
amount paid and not the whole order price is to be reported
as Unearned Income.
10 Miral borrowed money from the bank. The payment of the Liability> Non- Long-Term Note Payable
principal is scheduled on December 30, 20a6 which is two current
years from now. Hence, this is a Long-term Liability. Also,
because Mira signed a promissory note, the liability can be
referred to as Long Term Note Payable.
11 Based on the accounting equation: A=L+OE, it can be Equity Mira Capital
inferred that the balance of the lone equity account.
Owner’s Capital, is P 57,450. Total Assets is P 94,955 while
Total Liabilities is P 37,505. Following A=L+OE, Equity is P
57,450.
 Mira’s Store
Statement of Financial Position
As of December 31, 20A4

Assets

Current assets
Cash P44,535.00
Accounts receivable 575.00
Inventory 15,345.00
Prepaid rent 5,000.00
Total current assets 64,455.00
Non-current assets
Property, plant, and equipment 30,000.00
Accumulated depreciation (500.00)
Net book value 29,500.00
Total assets P94,955.00

Liabilities and Owner’s Equity

Current liabilities
Accounts payable P8,110.00
Salaries payable 1,000.00
Utilities payable 4,000.00
Unearned income 1,395.00
Total current liabilities 14,505.00
Non-current liabilities
Long term not payable 23,000.00
Total liabilities 37,505.00
Owner’s equity
Mira, capital 45,450.00
Total liabilities and equity P94,955.00

2. It is possible to infer the net income for the year ended December 31, 20A4 from the transaction entries
in the Mira, Capital account. Using what was learned from the concepts of normal balances, debits,
and credit, we can recreate the T-account of Mira, Capital.

Mira Capital
Beg. Balance P0
Withdrawal 15,000 Contribution 30,000
Additional contribution 5,000
Net income ?
Ending Balance P57,450

Figure 11: analysis of Mira, Capital using a T-Account

Based on the above T-account, it can be determined that the net income of Mira’s Store for 20A4
is P37,450. A more direct approach of determining net income through the preparation of the
Statement of Comprehensive Income will be covered in Chapter 2.
End of Chapter Summary

1. The Statement of Management’s Responsibility states that the company’s management, and not the
independent auditors, is responsible for the information content on the FS.
2. The Independent Auditor’s Report informs the reader of the opinion of the auditor on the fairness of
the financial statements based on their audit. Fairness refers to the correctness of the information
based on the generally accepted accounting standards. In the Philippines, the adopted standard is
the Philippines Financial Reporting Standards.
3. The Statement of Financial Position or Balance Sheet reports the resources available for the company
t use, obligation that the company is required to settle and the equity that belongs to the owners of
the company.
4. The SFP is a snapshot of the financial position of the company.
5. The SFP is the main financial statement because the bottom lines of the other three financial
statements find their way on this financial statement.
6. The SFP is a report based in the accounting equation: Assets = Liabilities = + Owner’s Equity.
7. Assets are resources that are within control of the company and have future benefits.
a. Cash refers to money readily available to be used in the company’s operations. The cash
account reports the balances of cash in bank (savings and checking account) as well as bills,
coins and checks on hand.
b. Receivable are assets that pertain to the company’s right to collect or right to claim payment.
c. Inventory refers to the cost of unsold merchandise that the company purchased for the
purpose of reselling to its customers in the normal course of its business.
d. Prepaid expense is an asset account that refers to future expenses paid in advance before the
services or the goods are used.
e. Property, plant, and Equipment (PPE) are long-term assets which are used in the operations
of the company.
f. Intangible assets are long-term assets that have no tangible properties.
8. Liabilities are obligations that the company is required to pay.
a. Payables are obligations to make payments.
b. Accounts payable (AP) are obligation to the suppliers of purchased inventories.
c. Notes Payable (NP) refers to the obligation to pay documented in a promissory note.
d. Accrued Expenses refers to the obligation to pay for goods and services already used in the
operation of the business such as salaries payable, utilities payable, rent payable and interest
payable.
e. Unearned income refers to advance payments made by customers while goods and services
are not yet delivered to the customer.
f. Long-term liabilities are obligations to pay to be settled at some specific date that is more
than one year away from the date of the SFP.
9. Equity is equal to the net assets of the business. For sole proprietorship, the equity account is the
Owner’s Capital. It is composed of the owners’ investments and the accumulated net income of the
company, net of any distributions to the owners.
10. The SFP may be presented using two acceptable formats: the account from and report form.
a. The account form follows the general ledger T-account format – assets on the left and
liabilities and equity on the right.
b. The report form SFP is a simple listing – assets are listed first, followed by liabilities and finally
the equity account.
c. A classified SFP presents assets and liabilities classified as to current and non-current.
i. Assets are classified as current if it can be used or converted to cash within one year.
ii. Current liabilities are payables scheduled to be paid within one year of the date of the
Statement of Financial Position.
11. Debit and credit refers to the sides of the T-account format-debit on the left and credit on the right.
12. An account is increased by an entry on the side of its normal balance and decreased by an entry on
the opposite side of its normal balance.
13. The normal balance of asset account I debit.
14. Liabilities and equity have normal balances of credit.