INTRODUCTION TO ACCOUNTING AND USERS
OF ACCOUNTING INFORMATION classified.
DEFINITION OF ACCOUNTING
According to Accounting Standards Council, accounting
is a service activity in which function is to provide
quantitative information, primarily financial in nature,
about economic entities, that is intended to useful in
making economic decisions.
The American Institute of Certified Public Accountants
defines accounting as art of recording, classifying and
summarizing in a significant manner and in terms of
money,
transactions and events which are in part at least of a
financial character and interpreting the results thereof.
 Recording involves keeping a chronological order
of transactions in journal and ledger.
 Classifying is the process of categorizing the
accounts in leger and financial statements.
 Summarizing is summing up the financial data in
each accounting period.
The American Accounting Association stated that
accounting is the process of identifying (analytical
component), measuring (technical component) and
communicating (formal component) economic information
to permit informed judgment and decision by user of the
information.
 Identifying is the recognition or non recognition of
business activities.
 Measuring is the process of assigning of per
amount.
 Communicating deals with preparing and
distributing accounting reports to its users.
NATURE OF ACCOUNTING
Accounting is a service activity. Accounting provides
assistance to decision makers by providing them financial
reports that will guide them in coming up with sound
decisions.
Accounting is a process. A process refers to the method of
performing any specific job step by step according to the
objectives or targets. Accounting is as a process as it
performs the specific task of collecting, processing and
communicating financial information. In doing so, it follows
some definite steps like the collection, recording,
classification, summarization, finalization, and reporting of
financial data.
Accounting is both an art and a discipline. Accounting is
the art, which refers to the way something is performed, of
recording, classifying, summarizing and finalizing financial
data. It involves creativity and skill to help us attain some
specific objectives.
Accounting is a systematic method as it follows certain
standards and professional ethics, it is also a discipline.
Accounting deals with financial information and
transactions. Accounting involves recording of financial
transactions and data which are classified and finalized in a
given specified period of time. It deals with financial
information sought by its users which are recorded and
Accounting is an information system. Accounting is a
storehouse of information as it collects processes and
communicates financial information of any entity.
Business transactions are analyzed, recorded, classified and
summarized to be able to prepare the financial statements
for decision making. Source documents are important
because these are the evidence of transactions. Analysis of
business transactions can be done through the accounting
equation.
HISTORY OF ACCOUNTING
The Cradle of Civilization-Around 3600 B.C., record-
keeping was already common from Mesopotamia, China and
India to Central and South America. The oldest evidence of
this practice was the “clay tablet” of Mesopotamia which
dealt with commercial transactions at the time such as listing
of accounts receivable and accounts payable.
14th Century - Double-Entry Bookkeeping-The most
important event in accounting history is generally
considered to be the dissemination of double entry
bookkeeping by Luca Pacioli (The Father of Accounting) in
14th century Italy. The Italians of the 14th to 16th centuries
were the first to commonly use Arabic numerals, rather than
Roman, for tracking business accounts. Luca Pacioli wrote
Summa de Arithmetica, the first book published that
contained a detailed chapter on double- entry bookkeeping.
French Revolution (1700s)-The thorough study of
accounting and development of accounting theory began
during this period. Social upheavals affecting government,
finances, laws, customs and business had greatly influenced
the development of accounting.
The Industrial Revolution (1760-1830)-Mass production
and the great importance of fixed assets were given attention
during this period.
19th Century – The Beginnings of Modern Accounting in
Europe and America-The modern, formal accounting
profession emerged in Scotland in 1854 when Queen
Victoria granted a Royal Charter to the Institute of
Accountants in Glasgow, creating the profession of the
Chartered Accountant (CA). The first national U.S.
accounting society was set up in 1887. Rapid changes in
accounting practice and reports were made in this period.
The Present - The Development of Modern Accounting
Standards and Commerce- The accounting profession in
the 20th century developed around state requirements for
financial statement audits. Beyond the industry's self-
regulation, the government also sets accounting standards,
through laws and agencies such as the Securities and
Exchange Commission (SEC). As economies worldwide
continued to globalize, accounting regulatory bodies
required accounting practitioners to observe International
Accounting Standards. This is to assure transparency and
reliability, and to obtain greater confidence on accounting
information used by global investors.
THE USERS OF FINANCIAL INFORMATION
The users of accounting information are classified into
internal and external users.
1. Internal Users. These are people within a business
organization who use financial information. They
are directly involved in management and
operation of business.
Examples:
 Management for planning and controlling the
operation of the business.
 Owner/s of the firm need to know if the
business is operating at a profit or loss.
 Employees are interested in information
regarding the profitability and stability of an
enterprise so they can assess their employment
status, and whether the company has the ability
to provide better remuneration and additional
benefits.
2. External Users. These are individuals outside a
business organization who use financial information.
They are not directly involved in management
and operation of business.
3.
Examples:
 Creditors and suppliers in order to evaluate a
borrower’s ability to pay and I deciding whether to
extend credit to a debtor.
 Investors to determine if their investment is
profitable and safe and in deciding whether to invest
or not, or whether they should buy, hold or sell their
shares of stocks.
 Government and their Agencies. In order to regulate
the activities of the enterprise, determine taxation
policies and as basis for national income statistics.
Examples of such agencies are Bureau of Internal
Revenue (BIR), Securities and Exchange
Commission (SEC) and Department of Trade and
Industry (DTI).
 Customers use financial statements as basis for
evaluating the possibility of price changes and
identifying other sources of cheaper services and
commodities.
 Trade Associations use financial data to report
industry statistics; industry comparisons and
analysis in order to that firms belonging to the same
industry can make relevant economic decisions.
Other users of financial information include financial
analysts and advisors, lawyer, media or press and the
general public.
ACCOUNTING CONCEPTS AND PRINCIPLES
ACCOUNTING EQUATION
ACCOUNTING CONCEPTS AND PRINCIPLES
1. Going Concern or Continuity Principle- means
that in the absence of evidence of its ceasation, the
business or accounting entity will continue its
operation indefinitely.
It is the foundation of the cost principle where
assets are initially recorded at
cost or purchased price.
Example: The person who prepares financial statements
should assume that the entity will continue indefinitely.
2. Business Entity Principle says that entity is
separate and distinct from the owners, managers,
and employees who constitute the entity.
Example: If a person has driving business, the cash from
services rendered should be reported separately from
personal cash.
3. Time Period Principle states that preparation of
financial statements should be divided into
accounting periods which are usually of equal
intervals. Accounting period may be a calendar year
or a natural business year.
Example: Jollibee should report financial statements
quarterly.
4. Monetary Unit Principle explains that amounts are
reported into a single monetary unit.
Example: McDo should report financial statements in peso
even they have branches in other countries that have
different currencies.
5. Materiality Principle dictates that strict compliance
with GAAP is not required as long as the items are
immaterial or insignificant to affect the decision
making or fairness of the financial statements.
Example: An error in the financial statement of
multinational company may be immaterial but not in startup
businesses
6. Conservatism Principle or Concept of Prudence
means that “in case of doubt”, record any loss and
do not record any gain.
Example: In case of doubt, expenses should be reported at a
higher amount which results in decrease of revenue.
7. Disclosure Principle states that all relevant and
material information should be disclosed or
reported.
Example: ABC Company should report all relevant
information and if needed, include on notes to financial
statements.
8. Accrual Basis implies that revenue should be
recognized when performed regardless of when cash
is received, while expenses should be recognized
when incurred regardless of when it was paid. On
the other hand, Cash Basis recognizes revenue
 when cash is received and recognizes expenses Accounts Affected Effect
when cash is paid. Office Supplies - Decrease
Cash - Increase
Example: XYZ received Php 20,000 for payment of
services on January but performed the services next month. The return of office supplies will decrease the office
Under the accrual basis, revenue is recognized on February; supplies of the company. The refund will increase the Cash
however, under the cash basis income should be reported on Account.
the date of collection or on January.
4. Purchased office equipment worth Php 20,000 on credit.
9. Matching Principle states that revenue should be
matched on expenses. Accounts Affected Effect
Office Equipment - Increase
Example: When you provide services, there were costs Accounts Payable - Increase
incurred directly and should be reported for that period.
The effect of purchasing office equipment will increase its
THE ACCOUNTING EQUATION account. Since office equipment was purchased on credit (on
account), the Accounts Payable which is a liability account
Business transactions are analyzed, recorded, classified and also increases.
summarized to be able to prepare the financial statements
for decision making. Source documents are important 5. Issued check in payment of the office equipment
because these are the evidence of transactions. Analysis of purchased on July 4.
business transactions can be done through the accounting
equation: Accounts Affected Effect
Accounts Payable - Decrease
Assets = Liabilities + Owner’s Equity Cash - Decrease
The left side of the equation shows the assets while the right The liability account was decrease due to the payment;
side shows who provide the funds or resources needed by likewise, the Cash Account will decrease because it was
the business. Equity means right to properties and liabilities paid.
is placed before equity because creditors have preferential
rights on the assets of the entity.
TIPS IN ANALYSING BUSINESS TRANSACTIONS:
 There are always two or more accounts affected
or involved in every transaction. 6. Paid office rent amounting to Php 15,000 for the month
 The effect of transactions on the accounts of July.
involved an increase or a decrease.
 Transactions are analyzed in the point of view of Accounts Affected Effect
the business Rent Expense - Increase
Cash - Decrease

Illustration of business transaction that affect the accounting The payment was for office rental, so it charged to Rent
equation: Expense Account. Every time expense is paid, particular
expense account increases while cash decreases.
1. Mr. Ricardo Miranda invested Php 400,000.
7. The owner withdrew Php 15,000 for personal use.
Accounts Affected Effect
Cash - Increase Accounts Affected Effect
Miranda, Capital - Increase Miranda, Drawing - Increase
Cash - Decrease
The business received cash which increases the Cash
Account. The amount received represents investment so
it will also increase Capital Account. In proprietorship, the owner is the one managing using
his/her efforts, time and resources in running the business.
2. Acquired office supplies amounting to Php 10,000 The owner can sometimes withdraw cash and/or non-cash
items for personal use. Such withdrawals are charged to
Accounts Affected Effect Withdrawal Account which decreases Cash Account.
Office Supplies - Increase
Cash - Decrease 8. Received cash payment for services rendered worth Php
45,000.
Office supplies were acquired by the firm so it will Accounts Affected Effect
increase its Office Supplies Account. The payment of Cash - Increase
cash decreases the Cash Account of the business. Service Revenue - Increase

3. Received refund for defective office supplies worth Php A service business earned its revenue/income from
5,000 performing services to customers or clients. Once services
have been done or rendered whether cash or on account, statement accounts. So, effectively, there are five major
Revenue Account increases because it is considered earned accounts.
or recognized.
 Assets – A resource controlled by the entity as
9. Rendered services to customers on account amounting a result of past events. An economic resource
to Php 50,000. is a right that has the potential to produce
economic benefits.
Accounts Affected Effect  Liability – A present obligation of the entity to
Accounts Receivable - Increase transfer an economic resource as a result of
Service Revenue - Increase past events. An obligation is a duty of
responsibility that the entity has no practical
The company will have receivables or collectibles from the ability to avoid.
customer whom services were rendered on account. This  Owner’s Equity – The residual interest in the
transaction both increases the Accounts Receivable and assets of the enterprise after deducting all its
Service Revenue Account. liabilities.
 Income – Increases in assets or decreases in
10. Collected the payment of services rendered on July 9. liabilities, that result in increases in equity,
other than those relating to contributions from
Accounts Affected Effect holders of equity claims.
Cash - Increase  Expenses – Decreases in assets or increases in
Accounts Receivable - Decrease liabilities, that result in decreases in equity.

The Cash Account will increase as the company

collected its receivable; however, will decrease the
latter account. POINTERS TO REMEMBER

Accounts Normal Increase Decrease

SUMMARY OF BUSINESS TRANSACTIONS: Balance through through
Assets Debit Debit Credit
Liabilities Credit Credit Debit
ASSETS = LIABILITIES + OWNER’S Owner's Credit Credit Debit
EQUITY equity
Income Credit Credit Debit
Expenses Debit Debit Credit

A journal is a detailed record of all the transactions done by

a business. Whenever an event occurs or a transaction
happens, it records in a journal. Journal can be of two types
– general journal and a special journal.

WHAT IS GENERAL JOURNAL?

The general journal is the book of original entry. It is where

the company initially records all the business transactions
that affects assets, liabilities or equity of a company. For
example, recording depreciation, expense, income and etc.

It also provides the chronological order of all non-

specialized activities, and the recording of these events must
follow the accounting equation which specifies that assets
must be equal to liabilities plus shareholders' equity.
THE FIVE MAJOR ACCOUNTS:
Note: Not all business events are recorded in journal. Only
1. Assets accountable events that affects the account balances of a
2. Liability company's financial statements.
3. Owner’s Equity
4. Income GENERAL JOURNAL FORMAT EXAMPLE
5. Expenses

POINTERS TO REMEMBER

There are five major accounts in accounting, namely: assets,

liabilities, owner's equity, revenues and expenses. Though
revenues and expenses are under owner's equity account,
they are shown separately because they are main income

Notice that it usually has date of transaction, short
description/memo, debit amount, credit amount, and a
reference number (referencing to journal ledger as an easy
indicator).
WHAT IS SPECIAL JOURNAL?
A special journal is used to record the most frequently
occurring transactions of a business. It records specific types
of high-volume information that would otherwise be
recorded in and overwhelm the general ledger.
There are mainly four kinds of specialty journals – Sales
journal, Cash receipts journal, Purchases journal, and Cash
disbursements journal. The total amounts in these journals
are periodically transferred to the general ledger in summary
form. Moreover, the company can have more special
journals depending on its needs and type of transactions.
SPECIAL JOURNAL EXAMPLE
A ledger is the book of final entry. It summarizes the
transactions of a business and aggregate the amount of each
account being debited and credited in the journal. It has
individual accounts that record assets, liabilities, equity,
revenue, expenses, gains, and losses.
WHAT IS GENERAL LEDGER?
General ledger is an accounting document that holds
accounting information needed to prepare the company's
financial statements. It summarizes a subsidiary ledger's
account balances, and it is where total balances of each
account are located. Furthermore, transaction data is
segregated by type into assets, liabilities, owners' equity,
revenues, and expenses accounts.
FORMATS OF GENERAL LEDGER
Note: You can choose any of these formats unless the
problem states so.
Notice that both formats have account title, date and account
balance.
WHAT IS SUBSIDIARY LEDGER?
A subsidiary ledger is a group of similar accounts whose
combined balances equal the balance in a specific general
ledger account.
For example, an accounts receivable subsidiary ledger
(customers' subsidiary ledger) includes a separate account
for each customer who makes credit purchases. The
combined balance of every account in this subsidiary ledger
equals the balance of accounts receivable in the general
ledger. Posting
a debit or credit to a subsidiary ledger account and also to a
general ledger control account does not violate the rule that
total debit and credit entries must balance because
subsidiary ledger accounts are not part of the general ledger;
they are supplemental accounts that provide the detail to
support the balance in a control account.
SPECIAL LEDGER EXAMPLE
PREPARATION OF FINANCIAL STATEMENTS
Key Terms:
a. Worksheet – a device used to simplify the adjusting and
closing process (this is not a financial statement).
b. Statement of Financial Position – or the balance sheet
provides the assets, liabilities, and equity of an entity at a
specific date. All accounts found on this financial statement
are real
accounts.

c. Statement of Financial Performance – or the Income

Statement (also, Statement of Comprehensive Income)
provides the summary of revenues and expenses of an entity
of a specific period. All accounts found on this financial
statement are nominal accounts.

d. Statement of Changes in Owner’s Equity – FS

providing the movement of the equity account of an entity.
Additional information:
e. Statement of Cash Flows – FS providing the movement
a. Prepaid rent covers the rent for January 2020.
(inflows and outflows) of cash of an entity of a certain
b. Supplies on hand, P5,000.
period.
c. The furniture and fixtures were bought on April 1, 2020,
with no salvage value and an estimated useful life of three
f. Cross-footing – the process of combining of unadjusted
years.
balances with the adjustments such that:
d. The office equipment was bought on July 30, 2019.
e. Unearned Service Revenues include P250,000 rendered
Debit + Debit – Credit = Adjusted Balance
services.
Or
Credit + Credit - Debit = Adjusted Balance
Requirement: Prepare the worksheet for Valencia
Accounting Firm. Use the worksheet on the following page.
SAMPLE WORKSHEET

THE FINANCIAL STATEMENTS

Using the worksheet is easy. The figures for the unadjusted
balance will be the inputs for the Trial Balance columns of
the worksheet. The Adjustments columns’ input will be
copied from the
adjusting entries. The adjusted trial balance figures will be
from the cross-footing process.
The income statement columns will be copied from the
adjusted Revenues and Expenses accounts. The same will be
done with the balance sheet columns, but Assets, Liabilities,
and Equity accounts will be copied. The financial statements
should always be balanced in the end.
A. Statement of Financial Performance/Income
Statement/Statement of Comprehensive Income
- This financial statement presents the summary of all
revenue and expense items of the entity for the given period
of time.
- Information regarding the performance (profitability) of
the enterprise is required to assess potential changes in
economic resources to control in the future. In this reason,
the expenses are arranged from the highest to lowest
amounts (except for Miscellaneous Expenses, which will
always be the last regardless of the amount).

Illustrative Exercise 1:

B. Statement of Financial Position/Balance Sheet
- This financial statement presents the financial
position/condition of entity.
- This financial statement enlists all assets, liabilities and
equity of an entity in net amount at a given point in time.
- This FS is used to evaluate an entity’s liquidity (for short
term obligations), solvency (for long term obligations),
financial flexibility, and the ability to generate profits.
- Items in this FS are arranged by decreasing liquidity (likely
to be converted to cash in short period of time).
*Note that the net figures of the non-current assets presents
the net amounts. Meaning, Cost less the accumulated
depreciation.
*Note that the Capital account is already adjusted
(Beginning Balance less withdrawals and loss). This amount
will be seen in the Statement of Changes in Owner’s Equity.
*Note that the prepaid rent is not presented because it has
no balance on the account anymore. No need to present an
item if it has no balance.
C. Statement of Changes in Owner’s Equity
- This financial statement presents the movement of the
equity account. This account is affected by withdrawals,
profit (loss), and additional capital.
*Note that if there is no additional investment or profit, do
not include it anymore. It is presented onthe example for
illustrative purposes.
D. Statement of Cash Flows
- This financial statement presents inflows and outflows of
cash. Remember that this FS revolve only to CASH. Any
non-cash items should be removed.
CLASSIFICATIONS OF CASH FLOWS
1. Operating Activities
- Items that primarily affects the determination of profit and
loss. This mainly comes from the normal operations of the
entity.
2. Investing Activities
- Items including making and collecting loans, acquiring and
disposing of property plant and equipment, and other
productive assets, investments in debt and equity
instruments.
3. Financing Activities
- Items from obtaining or distributing resources from/to the
owners and creditors.
*Note that after the preparation of the Statement of Cash
Flows, the net balance of cash should be equal to the cash
balance found in your SFP.
JOURNALIZE CLOSING JOURNAL ENTRIES
The nominal accounts are the only items closed in the books
of an entity. They are also called temporary accounts. These
accounts accumulate all the transactions of only one
accounting period. In the end of the accounting period, they
will be closed to the owner’s capital account. In summary,
all nominal accounts should be transferred to the capital
account leaving no (0) balance.
STEPS IN JOURNALIZING CLOSING ENTRIES
1. Close the Revenues and Expenses Accounts
The revenue and expenses are closed to a summary account
called “Income Summary”.
PRO FORMAT CLOSING JOURNAL ENTRIES
*Note that the revenue has a normal balance of credit;
therefore, it should be debited to zero out the balance. Our
main goal is to make the balances of temporary accounts 0.

* Note that the expenses have normal balances of debit;

therefore, it should be credited to zero out the balance. The
expenses should be listed one-by-one because they have
their own separate ledgers.

2. Close the Income Summary Account

After closing the revenue and expenses account, the balance
of income summary (debit balance signifies profit and credit
balance signifies loss) will be closed to the capital account.

PRO FORMAT CLOSING JOURNAL ENTRIES

Income Summary xx
Capital xx
To close the income summary account.

*This entry is used if the entity gains a profit. If loss, the

capital account should be debited and the income summary
should be credited.

3. Close the Withdrawal account

PRO FORMAT CLOSING JOURNAL ENTRIES

Capital xx
Withdrawals xx

Once the closing journal entries have been entered into the
general journal, the information should be posted to the
general ledger. All of the nominal accounts in the general
ledger should
have zero balances. To double check on this, another trial
balance (called Post Closing trial balance) will be prepared
based on the new balances in the general ledger.