Chapter 1

Introduction to Accounting and Business

 You actually encounter accounting in your daily routine not knowing that you are
doing some accounting activity. As a student, you get an allowance from your
parents and use this to pay for certain expenses like transportation fare and
school supplies. At the end of the day, some of you have totally consumed your
allowance while others may have saved something and plan to use it in the
future. The process of receiving money, planning and allocating it according to
ones needs is a simple way of BUDGETING. This is one important area of
accounting.

 You probably own several gadgets such as computer, cellphone, shoes and bags
which amounts to P200,000. These are your ASSETS that make up your wealth
or NET WORTH. However if the computer was purchased for P40,000 using
credit card then not all the assets belong to you. The credit card company has a
claim over the computer. This is a LIABILITY which will decrease your NET
WORTH from P200,000 assets minus P40,000 liability equals your NET WORTH
which is now P160,000.

 If you are using your money for a business venture, you must make a record of
the progress of your financial activities. Here is where accounting comes in. How
does profit come about?
Money RECEIVED > Money PAID for buying goods = Profit
from selling goods and incurring expenses
With profit, assets will grow and so will net worth.

 When you plan to put up you own business with the assets you have
accumulated, you will need answers to the following questions
o Do I have enough capital or money to start a business? If not, how do I
raise enough funds?
o What other resources aside from cash, does this business need to operate
well?
o How much are the operating costs that I need to pay?
o Where should I locate the business?
You need business and accounting knowledge to be able to prepare a good
business plan.

 A business owner and other investors don’t want to be caught off guard. Time
and again they would like to know what is happening to the business. Accounting
provides financila information regarding the business by preparing the following
financial reports which are called General Purpose Financial Statements:
o Statement of Financial Position is a progress report showing a list of
assets and liabilities.
o Income Statement is a performance report of revenues against costs and
expenses.
o Statement of Cash Flows is a cash report showing where we got and
where we used the money.
o Statement of Owner’s Equity or Net Worth is a progress report showing
changes in wealth.

 Accounting has been around since as far back as 3300 BC, with archaeologists
having discovered accounting on clay tablets from Egypt and Mesopotamia.
In 1494, Luca Pacioli published "Summa Arithmetica, Geometria,
Proportioni et Proportionalita," describing the system of double-entry
bookkeeping used by Venetian merchants.
In 1923, accounting was legally recognized as a profession in the
Philippines when the sixth Legislature approved Act No. 3105 on March 17,
1923.

 A business is an economic unit that engages in buying and selling of goods or

services. When a person wants to put up his own business, the primary reason
is to earn profit. Profit generates more resourses or funds for the business. With
more funds, it is possible for business to expand. You need more workers and

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Introduction to Accounting and Business

this will create more job opportunities and more taxes are paid to the
government.

 You need money to start a business. The primary source of capital is the owner
or investor. A secondary source of capital is a relative, friend, cooperative, or
bank.

 Forms of Business Organization

o Proprietorship or Sole Proprietorshipis a business set up and managed
by one person. Usually the owner is also the manager of the business.
Advantages
 Only a small amount of capital is need.
 Its operation can be managed easily by the proprietor.
 The owner or proprietor gets all the profits.
 Ease in formation since only a minimum requirement to legally
operate is need.
Disadvantages
 Difficult to expand the business andsell different products or
services because of low capital and only one owner-manager.
 It has limited life. Owner may just one day want to close it, or
become incapacitated or die.
 Owner has unlimited liability. It means that if the business is unable
to pay its debt, the bank or creditor can attach the owner’s personal
properties.

o Partnership is a business owned by two or more persons called partners

who contribute money, property and talent into a common fund for the
purpose of sharing profit among themselves. Most often the partners are
also the managers.
Advantages
 Ease in managing the business and in attracting clients because of
more owners involved.
 Partnerships are easy and inexpensive to form.
 With more than one owner, the ability to raise funds may be
increased.
Disadvantages
 General partner has unlimited liability that affects personal assets in
case of insolvency.
 The partnership may have a limited life; it may end upon the
withdrawal or death of a partner.
 Profits must be shared with others.
 Since decisions are shared, disagreements can occur.

o Corporation is a legal “person” separate and distinct from its owners, and
it has many of the rights, duties, and privileges of an actual person.
Corporations can borrow money and own property, can sue and be sued,
and can enter into contracts. The owners of a corporation are its
shareholders. The shareholders elect a board of directors to oversee
the major policies and decisions.
Advantages
 Corporations can raise additional funds through the sale of stock.
 Can afford to hire experts to efficiently manage and operate the
business.
 Shareholders have limited liability for the corporation’s debts.
 Ownership (represented by shares of stock) can be readily
transferred.
 The life of the corporation is not limited.
Disadvantages
 Complicated in formation and operation.
 Separation of ownership and management. Shareholders vote for
the board of directors, and the directors turn day-to-day operations
over to a professional management team.

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 Corporations are subject to more government regulation.

 Subject to double taxation. They are taxed the first time when the
corporation pays taxes on its profits. Then they are taxed a second
time when investors, as the owners of the corporation, report their
dividends as personal income.

 Types of Business Operation

o Service Businessis one which provides services for fee to clients or
customers. Examples: barbershop, travel agency, internet shop, school
and arline.
o Merchandising Business is one which buys and sells goods or
merchandise. Examples: shoe store, bookstore and drugstore.
o Manufacturing Business is one who buys raw materials, process these
into finished goods and then sells these to customers. Examples: shoe
factories and food processors.

 Accounting is a service activity. Its function is to provide quantitative

information primarily financial in nature about economic entities that is intended
to be useful in making economic decisions.
Accounting may also be defined as the art of recording, classifying and
summarizing in a significant manner and in terms of money, transactions and
events which are part at least of a financial character and interpreting the results
thereof.Technically, recording is referred to as bookkeeping. BOOKKEEPING is
defined as the systematic and chronological recording of business transactions
or events.

 Accounting is often called “the language of business” because it communicates

financial information about a business enterprise to different interested parties.
There are two broad categories of accounting information users: internal users
and external users.

 Users of Financial Information

o Internal users are those inside that helps run its operations and uses the
company’s financial information to make decisions.
 Management. In small businesses, management may include the
owners. In huge organizations, however, management is usually
made up of hired professionals who are entrusted with the
responsibility of operating the business or a part of the business.
They act as agents of the owners.The owners are particularly
interested in the entity’s ability to generate profit. Managers need
the information to protect the property of business from fraud,
mismanagement, to make specific decision, to plan for future, to
measure the performance.
 Employees are interested in the company’s profitability and
stability to gauge job security and future remuneration.They are
after the ability of the company to pay salaries and provide
employee benefits. They may also be interested in its financial
position and performance to assess company expansion
possibilities and career development opportunities.

o External users are those who make decisions concerning their

relationship to the enterprise.
 Investors use accounting information to determine whether or not
to invest in a company. Investors providing start-up capital ensure
the viability of companies seeking funding by reviewing their long-
term financial outlook. Buyers of stocks and bonds research
financial statements to help make trading decisions that provide
profitable returns.
 Creditors include suppliers as well as lenders of finance such as
banks.It is usual that these groups are interested to know the
financial soundness before granting credit. They are interested in
the company’s ability to pay obligations when they become due.

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Suppliers need to assess the financial health and payment history

of a company when selling on credit payment terms.Banks typically
require businesses to present financial statements when applying
for loans.
 Customers require information about the ability of the business to
survive and prosper. As customers of the company's products, they
have a long-term interest in the company's range of products and
services. They may even be dependent on the business for certain
products or services.
 Government agencies need a wide range of information to
regulate business entities’ activities, to determine taxation, to
calculate the national income and other macroeconomic indicators,
to examine the impact of the entity’s activity performance on the
environment, etc. Tax authorities need information on business
profitability for determining the credibility of the tax returns filed on
behalf of the company. Regulatory authorities need information
for ensuring that the company's disclosure of accounting
information is in accordance with the rules and regulations set in
order to protect the interests of the stakeholders who rely on such
information in forming their decisions.
 Public may be interested in the accounts of the business for social
obligation of business. The public is interested in pollution
abatement, community welfare program, ecological benefits or
hazards out of operation of the business. Public is interested to
know how national resources are being utilized by the organization
and their contribution in the economy.Financial statements may
assist the people by providing information about the trends and
recent developments in the prosperity of the enterprise and the
range of its activities.

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Manuel, Z. (2019). 21 Century Accounting Process (25 ed.) Raintree Trading & Publishing Quezon City