ACTBAS1: Introductory Accounting--Part 1

Basic Concepts

Three forms of business organization according to ownership

1. Sole proprietorship

2. Partnership

3. Corporation

Three forms of activities that can be performed by business organizations

1. Manufacturing

2. Merchandising

3. Servicing

Accounting is the process of communicating financial information about a business entity to users such as
shareholders and managers. The communication is generally in the form of financial statements that show in
money terms the economic resources under the control of management; the art lies in selecting and presenting the
information that is relevant to the user and is reliable.

General Characteristics

It is the process of identifying, measuring, and communicating economic information in order for users to
be able to make informed judgment and decisions accordingly.

It is a service activity used as basis of making decisions

It only deals with quantitative financial information about the economic entity intended to be useful in
making economic decisions.

It is commonly referred to as the language of business or communication of information because it

serves as the medium of disseminating information to users.

It is an art because skill and creativity is required.

It is a science because of the existence of a body of knowledge that governs the accounting practice known
as the Accounting theory.

Bookkeeping deals primarily with the step-by-step accomplishments of the accounting cycle.

Users of Accounting Information

1. Investors The providers of risk capital and their advisers are concerned with the risk inherent in, and
return provided by, their investments. They need information to help them determine whether they should
buy, hold or sell. Shareholders are also interested in information, which enables them to assess the ability
of the entity to pay dividends.

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2. Employees Employees and their representative groups are interested in information about the stability
and profitability of their employers. They are also interested in information, which enables them to assess
the ability of the entity to provide remuneration, retirement benefits and employment opportunities.

3. Lenders Lenders are interested in information that enables them to determine whether their loans, and
the interest attaching to them, will be paid when due.

4. Suppliers and other trade creditors Suppliers and other creditors are interested in information that
enables them to determine whether amounts owing to them will be paid when due. Trade creditors are
likely to be interested in an entity over a shorter period than lenders unless they are dependent upon the
continuation of the entity as a major customer.

5. Customers Customers have an interest in information about the continuance of an entity, especially
when they have a long-term involvement with, or are dependent on, the entity.

6. Governments and their agencies Governments and their agencies are interested in the allocation of
resources and, therefore, the activities of entities. They also require information in order to regulate the
activities of entities, determine taxation policies and as the basis for national income and similar statistics.

7. Public - Entities affect members of the public in a variety of ways. For example, entities may make a
substantial contribution to the local economy in many ways including the number of people they employ
and their patronage of local suppliers. Financial statements may assist the public by providing information
about the trends and recent developments in the prosperity of the entity and the range of its activities.

Four Functions of Accounting

1. Recording The recording process is popularly known as journalization. It is the chronological listing or
committing to writing of daily transactions or quantifiable events occurring in a business entity in the
books of accounts or journals and ledgers.

2. Classifying It is the process of grouping of business transactions into the elements of the financial
statementsasset, liability, capital, revenue, and expense.

3. Summarizing It is the process of preparing financial statements. For the purposes of this course, a
complete set of financial statements includes (1) an income statement, (2) a statement of changes in
owners equity, (3) a statement of financial position, (4) a statement of cash flows, and (5) the notes
accompanying the financial statements.

4. Interpreting It is the process of assessing and evaluating the financial statements in order to make
economic decisions that will facilitate development in business operations.

Information taken from the interpretation of financial statements includes the following:

i. Liquidity The availability of cash in the near future after taking account of financial commitments
over this period

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ii. Solvency The availability of cash over the longer term to meet financial commitments as they fall
due

iii. Stability The measure of a firms ability to carry on business operation.

iv. Profitability The ability of a firm to increase owners equity not from investment but from
earnings

v. Growth potential The estimated growth of a company based on past performance

vi. Effectiveness of management The capability of the management to effectively run the business
entity by maximizing the economic resources under the control of the entity

PICPA (Philippine Institute of Certified Public Accountants) - It is an umbrella organization of accountants in the
Philippines and is subdivided into the four following sectors:

1. ACPACI (Association of Certified Public Accountants in Commerce Industry)

2. ACPAPP (Association of Certified Public Accountants in Public Practice)

3. ACPAE (Association of Certified Public Accountants in Education)

4. GACPA (Association of Certified Public Accountants in Government)

DBM (Department of Budget and Management)

BOA (Board of Accountancy) The organization preparing and administering the CPA licensure exam

PRC (Professional Regulation Commission) The government-sanctioned organization that issues licenses to
successful examines of the CPA licensure exam.

FRSC (Financial Reporting Standards Councils formerly known as Accounting Standards Council) The body that
formulates the Philippine Accounting Standards

IFRS (International Financial Reporting Standards) These are principle-based international standards that serve
as the basis for the formulation of its adaptation in the Philippine setting

Specialized Uses of Accounting

1. Auditing is the examination of whether financial statements are upholding the standards that govern their
formulation.

2. Management Accounting/Cost Accounting aids management in making business decisions.

3. Taxation is the preparation of tax consequences in certain business endeavors.

4. General Accounting/Financial Accounting specializes in the preparation of financial statements.

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5. Government Accounting specializes in the use of the profession in various public sector entities in order
to effectively perform their functions in the government.

6. Accounting Systems/Management Services specializes on the design and installation of accounting

systems.

Basic Principles of Accounting

1. Economic entity All business transactions are separated from the personal transactions of the owners.

2. Stable monetary unit This principle as two assumptions. (1) Accounting only deals with business
transactions and events that are quantifiable or in other words expressed in monetary terms. (2) The
accountant also ignores the effect of inflation and makes no necessary restatements to the charging value of
currency.

3. Time period This principle assumes that it is possible to report the complex and ongoing business
activities in relatively short, distinct, time intervals. It requires that the indefinite life of business is
subdivided into time periods or accounting period, which are commonly equal in length in order to ensure
proper reporting at regular intervals.

4. Cost This principle states that costs refer to the amounts spent when an item was originally obtained. All
purchases must be recorded at original acquisition cost. For this reason, the amounts shown on financial
statements are referred to as historical cost. Assumption is going concern; cost is then valued at original
cost unless the business is expected to fail.

5. Full disclosure If certain information is important to an investor or lender using the financial statements,
the information should be disclosed within the statements or in the notes to the statement. All significant
and relevant information must be clearly communicated to users in order to avoid misleading users.

6. Going concern This accounting principle assumes that a company will continue to exist long enough to
carry its objectives and commitments and will not liquidate in the foreseeable future. If the companys
financial situation is such that the accountant believes that the company will not be able to continue on, the
accountant is required to disclose this assessment.

7. Matching (Expense Recognition) The matching principle requires that expenses be matched with
revenues. To match means to subtract the expenses from revenue. The resulting value is the income for the
period. All costs and expenses incurred in earning revenue should be reported in the same period in order
to determine the periodical financial position.

8. Revenue Recognition This principle dictates that revenue be recognized in the accounting period when
an increase in future economic benefits has occurred. Revenue is earned when the services have been
performed or the good has been delivered rather than the period when the cash was received. Therefore, it
is possible under this principle that revenue be earned while not receiving any cash or its equivalent.

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9. Accrual This principle states that the effects of transactions and other events are recognized when they
occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records
and reported in the financial statements of the periods to which they relate.

10. Materiality The relevance of information is affected by its nature and materiality. Information is material
if its omission or misstatement could influence economic decisions of users taken on the basis of the
financial statements. Materiality depends on the size of the item or error judged in the particular threshold
or cut-off point rather than being a primary qualitative characteristic which information must have if it is to
be useful.

11. Conservatism It is the inclusion of a degree of caution in the exercise of the judgments needed in making
the estimates required under conditions of uncertainty, such that assets or income are not overstated and
liabilities or expenses are not understated. However, the exercise of conservatism or prudence does not
allow, for example, the creation of hidden reserves or excessive provisions, the deliberate understatement
of assets or income, or the deliberate overstatement of liabilities or expenses, because the financial
statements would not be neutral and, therefore, not have the quality of reliability. This principle leads
accountants to anticipate and disclose losses.

12. Reliability/Objectivity This principle requires that accounting information has the quality of reliability
when it is free from material error and bias and can be depended upon by users to represent faithfully that
which it either purports to represent or could reasonably be expected to represent. It is the degree of
confidence users place on the truthfulness of the representations in the financial statements. To be reliable,
information must represent faithfully the transactions and other events it either purports to represent or
could reasonably be expected to represent. If information is to represent faithfully the transactions and
other events that it purports to represent, it is necessary that they are accounted for and presented in
accordance with their substance and economic reality and not merely their legal form. To be reliable, the
information contained in financial statements must be neutral, that is, free from bias.

13. Consistency The measurement and display of the financial effect of like transactions and other events
must be carried out in a consistent way throughout an entity and over time for that entity and in a
consistent way for different entities in order for the financial statements to achieve comparability.

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