CHAPTER 1

ACCOUNTING AND ITS ENVIRONMENT

 Fundamental Business Model

Capital 4 Sales
1

3
Business Owner
Operating Asset Products or
Cash
Assets Use Services
Banks

2
5 Return Costs

1. The investors provide the capital for the business. The cash investment will then be held in a bank
account.
2. The cash in the business can be:
a) Converted into another type of asset that will be used in the business or sold
b) Spent on operating cost such as salaries, rentals & utilities
3. The combination of business resources provides the basis for producing the products or services
4. The sale of product or service generates an asset called receivable. This asset once collected will
produce a cash inflow for the business
5. The cash inflow from collections will be used to:
a) Pay debts with interest on their loans to the company.
b) Return some cash to the owner
c) The rest of the cash can be sent back to the cycle (stage 2)

 Types of Business
Type of Business Activity Structure Examples
Service Selling people’s Hiring skilled staff and Software Development;
time selling their time Accounting Firm;
Law Firm/ Legal Firm
Trader Buying and selling Buying a product; Wholesaler;
products Making them for sale Retailer
as is
 Manufacture Designing Taking raw materials Vehicle Assembly;
products; and using equipment Construction;
Aggregating and staff to convert Engineering; Electricity;
components; and them into finished Water; Food and Drink;
Assembling goods Chemicals; Media;
finished products Pharmaceuticals
Raw Materials Growing and Buying blocks of land Framing; Mining; Oil
extracting raw and using them to
materials provide raw materials
Infrastructure Selling the Buying operating Transport (airport
utilization of assets (typically large operator, airlines,
infrastructure assets); Selling trains, ferries, buses);
occupancy often in Hotels; Telecoms;
combination with Sports facilities;
services Property Management
Financial Receiving Deposits, Accepting cash from Banks; Investment
Lending and depositors and paying House
Investing Money them interest using
the money to provide
loans to borrowers,
charging them fees
and interest higher
than the depositors
receive
Insurance Pooling Premiums Collecting cash from Insurance
of many to meet many customers;
claims of a few Investing the money
to pay the losses
experienced by a few
customers

 Forms of Business Organizations

Sole Proprietorship
REMEMBER!
Business Entity Concept /
Economic Entity Assumption
states that the recorded
activities of a business entity
  Single owner called proprietor
 The owner receives all profits and absorbs all losses and solely responsible for all
debts
Partnership
 Owned by two or more persons who bind themselves to contribute money, property
or industry to a common fund, with the intention of dividing the profits among
themselves
 Owners are called partners
 Each partner is personally liable for the debt incurred by the business
Corporation
 Owned by the stockholders
 Artificial being created by the operation of law, having
rights of succession and the powers, attributes and REMEMBER!
properties expressly authorized by law or incident to Corporation is a separate legal
its existence entity
 The stockholders are not personally liable for the debt
of the corporation

 Sizes of Business
Micro
 Net assets of P3M and below
 Less than 10 employees
Small
 Net assets of above P3M to P15M
 11-99 employees
Medium
 Net assets of above P15M to P100M
 100-199 employees
Large
 More than P100M net assets
 200 and above employees

 Activities in Business Organizations

Financing
 Obtaining financial resources
o Primary sources are owners and creditors
 Repaying creditors
 Paying a return to the owners
Investing
 Acquiring other resources used in the transformation process
 o Land, building equipment, etc.
 Disposal and replacement of these resources
Operating
 Involve the use of resources to design, produce, distribute and market goods and
services

 Definition of Accounting
 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 (Philippine Institute of Certified Public Accountants, PICPA)
 Accounting is the process of identifying, measuring, and communicating economic
information to permit informed judgments and decisions by the users of the information
(American Accounting Association, AAA)
 Accounting is the 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. (American Institute of Certified Public
Accountants)
 Accounting is an information system that measures, processes and communicates
financial information about an identifiable economic entity.

 BOOKKEEPING, ACCOUNTING and AUDITING

Bookkeeping – is the initial activity or clerical part of accounting. It is primarily concerned
with procedures in the making and keeping of accounting records. It is the “how” of
accounting.
Accounting – is the developed form of bookkeeping. It is the conceptual and logical part of
the service activity. It decides the methodology of such recording. It usually answers the
question “why”.
Auditing - is the critical part of accounting. It is performed after the accounting work ends.
After the financial statements are prepared, the auditor examines them to verify their
truthfulness and compliance with generally accepted accounting principles. Auditing
confirms the credibility of financial statements and protects or ensures the confidence of
financial users. It usually answers the question “how true”

 Phases of accounting
 Recording - this is the phase of accounting which involves the routine and mechanical
process of writing down the business transactions and events in the books of accounts in
a chronological manner called Journalizing.
o Classifying - this is the phase of accounting which involves sorting or grouping of similar
and interrelated transactions and events into their respective kind of classes. This is
actually the process of transferring the entries from the journal to the ledger called
Posting.
 o Summarizing - this is the phase of accounting which involves the completion of the
financial statements and the accounting requirements as well. This starts from striking
of a trial balance, plotting down of adjusting entries in the worksheet and the
preparation of closing entries, post-closing trial balance and reversing entries.
o Identifying - this is the phase of accounting which involves the “analytical and
interpretative work”. It is then, when financial statements are analyzed, interpreted
and communicated to those interested parties where these could be of great help to
management as a basis for making a sound decision.

 Specialized field or branches of accounting

Public Accounting - when accountants offer their professional services to clients for a fee like
other professionals (e.g., lawyers, doctors, and engineers). An accountant engaged in public
accounting is NOT an employee of a client company
o Branches of public accounting:
 External auditing
 Tax Services
 Management Advisory Services
Private Accounting – accountants are employees of a private enterprise or in a nongovernment
organization
o Branches of private accounting:
 Financial accounting – primarily concerned with the recording and classifying of
business transactions culminating in the preparation of general-purpose financial
statements or reports regarding the business’ financial position, operating results,
and cash activities in accordance with generally accepted accounting principles.
 Internal Auditing – deals with determining the operational efficiency of the
company regarding protection of the company’s assets, accuracy and reliability of
the accounting data, and adherence to prescribed managerial policies. The process
is known as financial internal auditing.
 Tax Accounting – embraces the preparation of various tax returns and tax planning
necessary to minimize the impact of taxes on the firm.
 Cost Accounting – has something to do with determining the inventory costs and/or
product costs of the manufactured goods and assisting in product pricing activities
of the company.
 Budgeting – covers the efficient management of cash by anticipating or predicting
monetary objectives in the future period.
 Accounting Systems Design – primarily includes the evaluation of the company’s
control system to find out any area of improvement.
 International Accounting – encompasses special accounting for international
transactions, comparisons of accounting principles in different countries, and
harmonization of diverse accounting standards worldwide and tax requirements of
all the countries in which the company does business.
  Not-for-Profit Accounting – deals with special accounting for charitable
organizations, philanthrophic foundations, religious groups, governmental agencies,
schools and cooperatives.
 Socio-economic Accounting – concerns the measurement of the impact of business
or governmental agency’s decision on the public sector.
Government Accounting - mainly focuses on the proper custody of government funds and their
purposes. Used for national government agencies and local government units (provinces, cities,
municipalities, and barangays)
Accounting Education - involves teaching accounting, taxation and some business subjects

 Fundamental Concepts

In accounting, these fundamental concepts are the generally accepted accounting principles which is a
collection of accounting standards, principles, and assumptions that define how financial information
will be reported.
 Accounting standards are the rules that determine the accounting for individual business
transactions.
 Accounting principles and assumptions provide the framework upon which accounting
standards are constructed.

 Characteristics of Financial Information

The primary goal of financial accounting is to provide information that is useful for decision making.
 Relevant information has the potential to impact decision making.
 Faithful representation means that the information accurately reflects an entity’s economic
activity or condition.
 CAPITAL PROVIDERS (Investors and Creditors) AND THEIR
Primary users of accounting information
CHARACTERISTICS

Constraints COST

Pervasive Criterion
DECISION USEFULNESS

Fundamental
RELEVANCE Qualities FAITHFUL REPRESENTATION

Productive Free from

Ingredients
Value ofConfirmatory
fundamental
Value
qualities
Completeness Neutrality Error

Timeliness
Enhancing Verifiability
Comparability Qualities Understandability

 Accounting Concepts
Monetary unit assumption or money measurement concept
o requires that financial reports be expressed in a single money unit, or currency.
Monetary unit used is normally determined by the country in which the company
operates, that is, Philippine peso in the Philippines

Time Period assumption or Accounting Period Concept

o allows a company to report its economic activities on a regular basis for a specific period
of time
 Calendar year – start on January 1, 2020, for example, and ends on December
31, 2020
 Fiscal year – start on any day, that is, March 1, 2020 and ends on February 28,
2021
Separate Business Entity assumption/concept
o limits the economic data in financial reports to that directly related to the activities of
the business and business entity is viewed as an entity separate and distinct from its
owners, creditors, or other businesses
 Going Concern Assumption/Concept
o Requires that financial reports be prepared assuming that the entity will continue
operating into the future. It justifies reporting items such as equipment, buildings, and
land at their initial or historical cost rather than liquidation or forced sale values
Dual Aspect Concept
o It states that in any point of time owner’s equity and liabilities for any accounting entity
will be equal to assets owned by that entity.
Cost Concept
o This concept states that an asset is ordinarily entered on the accounting records at the
price paid to acquire it.
The Matching Concept
o This concept is based on the accounting period concept. Says that revenues and
expenses should be recognized in the same period. In other words, income made by the
enterprise during a period can be measured only when the revenue earned during the
period is compared with the expenditure incurred for earning that revenue.
Accrual Concept
o Distinction between the receipt of cash and the right to receive it, and the payment of
cash and the legal obligation to pay it. The essence of this concept is that net income
arises from events that changes the owner’s equity in a specified period and that these
are not necessarily the same as change in the cash position of the business.
Realisation Concept
o Revenue is recognized when sale is made or revenue have been delivered or rendered.

 Accounting Conventions
1. Convention of Materiality – states that an accounting standard can be ignored if the net impact
of doing so has such a small impact on the financial statements that a reader of the financial
statements would not be misled.
2. Convention of Conservatism – requires that the accountants must follow the policy of playing
safe while recording business transactions and events; anticipating possible future losses but not
future gains. All probable losses are recorded when they are discovered, while gains can only be
registered when they are realized in the form of cash or assets.
3. Convention of Consistency – it requires that once the firm have decided on certain accounting
policies and methods and has used this for some time, it should continue to follow the same
methods or procedures for all subsequent similar events and transactions unless it has a sound
reason to do otherwise.

 Principles
measurement principle
o requires that amounts be objective and verifiable
 an amount is objective if it is based upon independent, unbiased evidence
 an amount is verifiable if it can be confirmed by a third party
  transactions between two independent parties, called arm’s-length
transactions, provide amounts that are objective and verifiable
revenue recognition principle
o the principle determines when revenue is recognized/recorded in the accounting
records. Normally, revenue is recorded when the services have been performed or
goods are delivered to the customers
expense recognition principle
o the principle, sometimes called the matching principle, requires expenses to be
recorded in the same period as the related revenue because doing so allows the
reporting of a profit or loss for the period
accrual principle
o income is recognized when earned regardless of when received
o expense is recognized when incurred regardless of when paid

 Application of accounting concepts and principles

Data Gathering. First, the office manager or any responsible officer of the company will transact
business which could either be done personally or be delegated to the company staff.
a. Entity concept. only business transactions are allowed to be recognized/recorded into the
books of accounts and such transactions should be authenticated by the manager of the
company.
b. Objectivity Principle states that transactions must be supported by pieces of evidence.
c. Verifiability principle. This principle is the effect of the application of the entity concept and
the objectivity principle. Because we can check on the authorization for the incurrence of
the said transactions, with their supporting evidence, they are verifiable. Any person
authorized by the company to verify the truthfulness of the transactions can examine this
document.
d. Reliability principle. This is the effect of the previous application of the accounting
principles. Because we apply the entity concept and the objectivity principle, it will make
our transactions reliable.

 Users of accounting information

1. Internal Users The Management Group
Owners
Managers of the business
Partners
Board of directors
Officers
Supervisors
 2. External Users Financing Group Public Group
Investors Government
Potential investors Regulatory agencies (SEC)
Trade creditors Taxing authorities (BIR)
Potential creditors Labor unions
Banks and other financial Employees
institutions Retirees
Economic planners
Customers

 Accounting Information System

Information System (IS) – is a formal, sociotechnical, organizational system designed to
collect, process, store, and distribute information
Information Systems – is an academic study of systems with a specific reference to
information and the complementary networks of hardware and software that people and
organizations use to collect, filter, process, create and also distribute data

 Parts of Information System

 People  Input Devices
 Procedure  The system unit
 Software  Secondary Storage
 System Software  Output Devices
 Application Software  Communication Devices
 Hardware  Data

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This diagram illustrates how

economic activities flow
into the accounting process,
which produces accounting
information, which are used
in making economic
decisions and taking specific
actions thus resulting to
economic activities
 Effective AIS should achieve the following objectives
Cost Benefit Principle – to process information efficiently at the least cost
Control Principle – to protect entity’s assets, to ensure that data are reliable, and to
minimize wastes and the possibility of theft and fraud
Compatibility Principle – to be in harmony with the entity’s organizational and human
factors
Flexibility Principle – to be able to accommodate growth in the volume of transactions
and for organizational changes

 Types of AIS
Manual Systems – utilize paper-based journals and ledger
Computer-based Transaction Systems – utilize computer-based journals and ledger
Database Systems – embed accounting data within the business event data on which they
are based

 Stages of Data Processing

INPUT PROCESSING OUTPUT