Overview of Accounting

Review of Accounting
Definition
Basic Purpose
Basic Concepts
Branches of Accounting
Sectors in the Practice of Accountancy
Importance of a Uniform Set of Financial Reporting Standards
What is Accounting?
Accounting is the process of identifying, measuring, and communicating
economic information to permit informed judgements and decisions by users of
the information.
- American Association of Accountants

Three important activities in accounting:

1. Identifying
2. Measuring
3. Communicating
Identifying
Its is the process of analyzing events and transactions to whether or not they will
be recognized.

Recognition refers to the process of including the effects of an accountable

event in the statement of financial position or the statement of comprehensive
income through a journal entry.

Only accountable events are recognized.

Accountable event or economic activity is one that affects

the assets, liabilities, equity, income or expenses of an entity.
Identifying
Non-accountable events (i.e., sociological and psychological matters) are not
recognized but disclosed only in the notes, if they have accounting relevance.

Disclosure only in the notes is not an application of the recognition process.

A non-accountable event that has an accounting relevance may be recorded

through a memorandum entry.
Types of Events or Transactions

1. External Events

These are events that involve the entity and another external party.

2. Internal Events
Types of External Events
1. Exchange (reciprocal transfer) – an event where there is a reciprocal giving
and receiving of economic resources or discharging of economic obligations
between the entity and an external party.
Examples:
Sale, Purchase, Payment of Liabilities, etc.

2. Non-reciprocal transfer – a “one way’ transaction in that the party giving

something does not receive anything in return while the party receiving does
not give anything in exchange.

Examples:
Donation, payment of taxes, theft, provision of
capital by owners, distribution to owners, etc.
Types of External Events

3. External event other than transfer – an event that involves changes in the
economic resources or obligations of an entity caused by an external party or
external source but does not involve transfers of resources or obligations.

Examples:
Vandalism, changes in the fair values and price levels, obsolescence, etc.
Types of Events or Transactions

1. External Events

These are events that involve the entity and another external party.

2. Internal Events

These are events that do not involve an external party.

Types of Internal Events
1. Production – the process by which resources are transformed into finished
goods.
Examples:
Conversion of raw materials into finished goods, conversion of farm products, etc.

2. Casualty – an unanticipated loss from disasters or other similar events (acts of

God).

Examples:
Loss from fire, flood, and other catastrophess.
What is Accounting?
Accounting is the process of identifying, measuring, and communicating
economic information to permit informed judgements and decisions by users of
the information.
- American Association of Accountants

Three important activities in accounting:

1. Identifying
2. Measuring
3. Communicating
Measuring
It involves assigning numbers, normally in monetary terms, to the economic
transactions and events.

Several measurement bases are used in accounting which include, but not
limited to, historical cost, fair value, present value, realizable value, current cost,
and sometimes inflation-adjusted costs. The most commonly used is historical
cost.

Accordingly, financial statements are said to be prepared using a mixture of

costs and values.

Costs: historical cost and current cost

Values: other measurement bases
Valuation by Fact or Opinion
The use of estimates is essential in providing relevant information. Thus, financial
statements are said to be a mixture of fact and opinion.
Opinion:
When measurement is affected by estimates, the items measured are said to be
valued by opinion.

Examples:
a. Estimated Uncollectible Accounts
b. Depreciation and amortization of expense
c. Estimated Liabilities (Provisions)
d. Retained earnings
Valuation by Fact or Opinion
Fact:
When measurement is unaffected by estimates, the items measured are said to
be valued by fact.

Examples:
a. Ordinary share capital valued at par value
b. Land stated at acquisition cost
c. Cash measured at face amount
What is Accounting?
Accounting is the process of identifying, measuring, and communicating
economic information to permit informed judgements and decisions by users of
the information.
- American Association of Accountants

Three important activities in accounting:

1. Identifying
2. Measuring
3. Communicating
Communicating
It is the process of transforming economic data into useful accounting
information, such as financial statements and other accounting reports, for
dissemination to users.
Also involves interpreting the significance of the processed information.

The communicating process of accounting involves three aspects:

1. Recording
Refers to the process of systematically committing into writing the
identified and measured accountable events in the journal through journal
entries.
Communicating
2. Classifying
Involves the grouping of similar and interrelated items into their respective
classes through postings in the ledger.
3. Summarizing
Putting together or expressing in condensed form the recorded and
classified transactions and events. This includes the preparation of financial
statements and other accounting reports.

Interpreting the processed information involves the computation of financial

statement ratios.
Some regulatory bodies, such as the Bangko Sentral ng Pilipinas (BSP), require
certain financial ratios to disclosed in the notes to FS.
Basic Purpose of Accounting
The basic purpose of accounting is to provide information that is useful in making
economic decisions.
Various sources of information are used when making economic decisions and
the financial statements are only one of those sources.
Other sources may include current events, industry publications, internet
resources, professional advices, expert systems, etc.

Economic entities use accounting to record economic activities, process data,

and disseminate information intended to be useful in making economic
decisions.
Economic Entity
An economic entity is a separately identifiable combination of persons and
property that uses or controls economic resources to achieve certain goals or
objectives.
An economic entity may either be a:
a. Not-for-profit entity
One that carries out some socially desirable needs of the community or its
members and whose activities are not directed towards making profit; or
b. Business entity
One that operates primarily for profit
Economic Activities
Economic activities are activities that affect the economic resources (assets)
and obligations (liabilities), and consequently, the equity of an economic entity.
Economic activities include:
1. Production
the process of converting economic resources into outputs of goods and
services that are intended to have greater utility than the required inputs.
2. Exchange
the process of trading resources or obligations for other resources or
obligations.
Economic Activities
3. Consumption
the process of using the final output of the production process.
4. Income distribution
the process of allocating rights to the use of output among individuals and
groups in society.
5. Savings
the process of setting aside rights to present consumption in exchange for
rights to future consumption.
6. Investment
the process of using current inputs to increase the stock of resources
available for output as opposed to immediately consumable output.
Types of Information Provided by
Accounting
1. Quantitative information
information expressed in numbers, quantities, or units.
2. Qualitative information
information expressed in words or descriptive form.
Qualitative information is found in the notes to FS as well as on the face of
the other FS.
3. Financial information
information expressed in money.
Also, a quantitative information.
Types of Accounting Information
Classified as to Users’ Needs
1. General purpose accounting information
 designed to meet the common needs of most statement users
 provided under financial accounting
 governed by Generally Accepted Accounting Principles (GAAP) represented
by the Philippine Financial Reporting Standards (PFRSs)

2. Special purpose accounting information

 designed to meet the specific needs of particular statement users.
 provided by other types of accounting other than financial accounting
Other Definitions of Accounting
a. Accounting as science & art
1. Social science – a body of knowledge which has been systematically gathered,
classified and organized.
2. Practical art – requires the use of creative skills and judgement.

Creative and Critical Thinking in Accounting

The practice of accountancy requires the exercise of creative and critical thinking.
1. Creative thinking involves the use of imagination and insight to solve problems by
finding new relationships (ideas) among items of information. It is important in
identifying alternative solutions.
2. Critical thinking involves the logical analysis of issues, using inductive or deductive
reasoning to test new relationships to determine their effectiveness. It is important in
evaluating alternative solutions.
Other Definitions of Accounting

b. Accounting as an information system

Accounting identifies and measures economic activities, processes information into
financial reports, and communicates these reports to decision makers.

c. Accounting as a language of business

Accounting is often referred to as a “language of business” because it is fundamental to
the communication of financial information.
Accounting Concepts
Accounting concepts refer to the principles upon which the process of
accounting is based.
The term “accounting concepts” is used interchangeably with the following
terms:
 Accounting assumptions (accounting postulates)
The fundamental concepts or principles and basic notions that provide
the foundation of the accounting process.
 Accounting theory
Organized set of concepts and related principles that explain and guide
the accountant’s action in identifying, measuring, communicating accounting
information.
Comprises the Conceptual Framework and the PFRSs.
Accounting Concepts
Some accounting concepts are implicit, meaning they are not expressly stated
in the Framework or PFRSs but are generally accepted because of their long-
time use in the profession.

Example of accounting concepts:

1. Double-entry system
Each accountable event is recorded in two parts – debit & credit.
2. Going concern assumption
The entity is assumed to carry on its operations for an indefinite period of
time.
Accounting Concepts
3. Separate entity (Accounting entity/ Business entity concept/ Entity concept)
The entity is viewed separately from its owners.
4. Stable monetary unit (Monetary unit assumption)
To be useful, accounting information should be stated in a common
denominator. (Common unit of measure, which is the peso in the Philippines)
5. Time period (Periodicity/ Accounting period)
The life of the entity is divided into series of reporting periods.
6. Materiality concept
Information is material if its omission or misstatement could influence
economic decisions.
Materiality is a matter of professional judgement and is based on the size
and nature of the item being judged.
Accounting Concepts
7. Cost-benefit (Cost constraint / Reasonable assurance)
The cost of processing and communicating information should not
exceed the benefits to be derived from it.
8. Accrual basis of accounting
The effects of transactions and other events are recognized when they
occur (and not as cash is received or paid).
9. Historical cost concept (Cost principle)
The value of an asset is determined on the basis of acquisition cost.
This concept is not always maintained. Some PFRSs require the departure
from this concept.
Accounting Concepts
10. Concept of Articulation
All of the components of a complete set of financial statements are
interrelated. Accordingly, when users use the financial statements in making
decisions, they need to use each financial statement in conjunction with the
other financial statements.
11. Full disclosure principle
This principle recognizes that the nature and amount of information
included in the financial statements reflect a series of judgmental trade-offs.
The trade-offs strive for:
a. Sufficient detail to disclose matters that make a difference to users, yet
b. Sufficient condensation to make the information understandable, keeping in
mind the costs of preparing and using it.
Accounting Concepts
12. Consistency concept
Financial statements are prepared on the basis of accounting principles
that are applied consistently from one period to the next.
Changes in accounting policies are made only when required or
permitted by the PFRSs or when the change results to more relevant and reliable
information.
Changes in accounting policies are disclosed in the notes.
13. Matching (Association of cause & effect)
Costs are recognized as expenses when the related revenue is
recognized.
Accounting Concepts
14. Entity theory
The accounting objective is geared towards proper income
determination. This theory emphasizes the income statement.
15. Proprietary theory
The accounting objective is geared towards the proper valuation of
assets. This theory emphasizes the importance of the balance sheet.
16. Residual equity theory
This theory is applicable when there are two classes of shares issued, i.e.,
ordinary and preferred. This theory is applied in the computation of book value
per share and return on equity.
Accounting Concepts
17. Fund theory
The accounting objective is directed towards cash flows, exemplified by
the formula “cash inflows minus cash outflows equals fund.” this concept is used
in government accounting and fiduciary accounting.
18. Realization
The process of converting non-cash assets into cash or claims for cash.
19. Prudence (Conservatism)
The use of caution when making estimates under conditions of
uncertainty, such that assets or income are not overstated and liabilities or
expenses are not understated.
Accounting Concepts
20. Matching Concept (Direct association of costs and revenues)
Costs that are directly related to the earning of revenue are recognized
as expenses in the same period the related revenue is recognized.
21. Systematic and rational allocation
Costs that are not directly related to the earning of revenue are initially
recognized as assets and recognized as expenses over the periods their
economic benefits are consumed, using some method of allocation.
22. Immediate recognition
Costs that do not meet the definition of an asset, or ceases to meet the
definition of an asset, are expensed immediately.
Common Branches of
Accounting
1. Financial accounting
The branch of accounting that focuses on general purpose financial
statements.
General purpose financial statements cater to the common needs of external users.
Primarily, the potential and existing investors, lenders and other creditors.

External users are those who are not involve in managing the entity.
Common Branches of
Accounting
Financial Accounting vs Financial Reporting

Financial Statements Financial Statements Financial Reporting

Financial Reporting
Financial reporting is the provision of financial information about an entity that is
useful to external users, primarily the investors, lenders, and other creditors, in
making investment and credit decisions.

Primary objective of financial reporting

To provide information about an entity’s economic resources, claims to those
resources, and changes in those resources.
Secondary objective of financial reporting
To provide information useful in assessing the entity’s management stewardship.
(How efficiently and effectively the entity’s management has discharged its
responsibilities to use the entity’s economic resources.)
Common Branches of
Accounting
2. Management accounting
Refers to the accumulation and communication of information for use by
internal users or management.
3. Cost accounting
The systematic recording and analysis of costs of materials, labor and
overhead incident to production.
4. Auditing
The process of evaluating the correspondence of certain assertions with
established criteria and expressing an opinion thereon.
Common Branches of
Accounting
5. Tax accounting
The preparation of tax returns and rendering of tax advice, such as the
determination of the tax consequences of certain proposed business endeavors.
6. Government accounting
The accounting for the government and its instrumentalities, placing
emphasis on the custody of public funds, the purposes for which those funds are
committed, and the responsibility and accountability of the individuals entrusted
with those funds.
7. Fiduciary Accounting
The handling of accounts managed by a person entrusted with the
custody and management of property for the benefit of another.
Common Branches of
Accounting
8. Estate accounting
The handling of accounts for fiduciaries who wind up the affairs of a
deceased person.
9. Social accounting (social and environmental accounting or social
responsibility reporting)
The process of communicating the social and environmental effects of an
entity’s economic actions to the society.
10. Institutional accounting
The accounting for non-profit entities other than the government.
Common Branches of
Accounting
11. Accounting systems
The installation of accounting procedures for the accumulation of
financial data and designing of accounting forms to be used in data gathering.
12. Accounting research
Pertains to the careful analysis of economic events and other variables to
understand their impact on decisions.
Bookkeeping VS Accounting
Four Sectors in the Practice of
Accountancy
Accountancy refers to the profession or practice of accounting.
Under R.A. 9298 also known as the “Philippine Accountancy Act of 2004,” the
practice of accounting is sub-classified into the following:
1. Practice of Public Accountancy
Involves the rendering of audit or accounting related services to more
than one client on a fee basis.
2. Practice in Commerce & Industry
Refers to employment in the private sector in a position which involves
decision making requiring professional knowledge in the science of accounting
and such position requires that the holder thereof must be a certified public
accountant.
Four Sectors in the Practice of
Accountancy
3. Practice in Education/Academe
Employment in an educational institution which involves teaching of
accounting, auditing, management advisory services, finance, business law,
taxation, and other technically related subjects.
4. Practice in the Government
Employment or appointment to a position in an accounting professional
group in the government or government-owned and/or controlled corporation,
including those performing proprietary functions, where decision making requires
professional knowledge in the science of accounting, or where civil service
eligibility as a certified public accountant is a prerequisite.
Accounting Standards
The Philippine Financial Reporting Standards (PFRSs) represent the generally
accepted accounting principles in the Philippines.
They comprise: (Standards & Interpretations)
1. Philippine Financial Reporting Standards (PFRSs)
2. Philippine Accounting Standards, and
3. Interpretations
PFRSs are accompanied by guidance to assist entities in applying their
requirements.
A guidance states whether it is an integral part of the PFRSs.
A guidance that is an integral part of the PFRSs is mandatory.
The Need for Reporting Standards
For financial statements to be useful, they should be prepared using reporting
standards that are generally acceptable.
The term “generally acceptable” means that either:
1. The standard has been established by an authoritative accounting rule-
making body, or
2. The principle has gained general acceptance due to practice over time and
has been proven to be most useful. (Implicit concepts)
Hierarchy of Reporting Standards
When selecting its accounting policies, an entity considers the following in
descending order:
1. Philippine Financial Reporting Standards (PFRSs)
2. In the absence of a PFRS that specifically applies to a transaction or event,
management shall use its judgment in developing and applying an
accountancy policy that results in information that is relevant and reliable.
In making the judgment,
1. Management shall refer to, and consider the applicability of the following
sources in descending order:
a. The requirements in PFRSs dealing with similar and related issues;
b. The Conceptual Framework
Hierarchy of Reporting Standards
2. Management may also consider the following:
a. Pronouncements of other standard-setting bodies
b. Accounting literature and accepted industry practices

Although the selection of appropriate accounting policies is the responsibility of

the entity’s management, the proper application of accounting principles is most
dependent upon the professional judgment of the accountant.
Accounting Standard Setting Bodies
and Other Relevant Organizations
1. Financial Reporting Standards Council (FRSC)
The official accounting standard setting body in the Philippines created
under the Philippine Accountancy Act of 2004 (R.A. No. 9298).
The FRSC is composed of fifteen (15) individuals – a chairperson who had been or
presently a senior accounting practitioner in any of the scope of accounting
practice and fourteen (14) representative members
Accounting Standard Setting Bodies
and Other Relevant Organizations
2. Philippine Interpretations Committee
A committee formed by the Accounting Standards Council (ASC), the
predecessor of FRSC, with the role of reviewing the interpretations of the
International Financial Reporting Interpretations Committee (IFRIC) for approval
and adoption by the FRSC.
3. Board of Accountancy (BOA)
The professional regulatory board created under R.A. 9298 to supervise
the registration, licensure and practice of accountancy in the Philippines. The
BOA consists of a chairperson and six (6) members appointed by the President of
the Philippines. The Board shall elect a vice-chairperson from among its members
for a term of one (1) year.
Accounting Standard Setting Bodies
and Other Relevant Organizations
4. Securities and Exchange Commission (SEC)
The government agency tasked in regulating corporations and
partnerships, capital & investment markets, and the investing public. Some SEC
rulings affect the accounting requirements of entities and the adoption and
application of accounting policies.
5. Bureau of Internal Revenue (BIR)
Administers the provisions of the National Internal Revenue Code. These
provisions do not always reflect the goals of financial reporting. However they do
at times influence the choice of accounting methods and procedures.
Accounting Standard Setting Bodies
and Other Relevant Organizations
6. Bangko Sentral ng Pilipinas
Influences the selection and application of accounting policies by banks
and other entities performing banking functions.
7. Cooperative Development Authority (CDA)
Influences the selection and application of accounting policies by
cooperatives.

Accounting policies prescribed by a regulatory body (e.g., BSP, CDA) are

sometimes referred to as regulatory accounting principles.
International Accounting
Standards
The International Accounting Standards Board (IASB) is the standard-setting body
of the IFRS Foundation with the main objectives of developing and promoting
global accounting standards.
The IASB was established in April 1, 2001 as part of the International Accounting
Standards Committee (IASC) Foundation. The IASC Foundation is a non-profit
organization based in Delaware, USA and is the parent of the IASB, which is
based in London. On July 1, 2010, the IASC Foundation was renamed to
International Financial Reporting Standards Foundation or IFRS Foundation.
The standards issued by the IASB are the International Financial Reporting
Standards (IFRSs), composed of the following:
1. International Financial Reporting Standards (IFRSs)
2. International Accounting Standards (IASs)
3. Interpretations
Other Relevant International
Organizations
1. International Financial Reporting Interpretations Committee (IFRIC)
Is a committee that prepares interpretations of how specific issues should
be accounted for under the application of IFRS where:
a. The standards do not include specific authoritative guidance; and
b. There is risk of divergent and unacceptable accounting practices.

The IFRIC is composed mostly of technical partners in audit firms but also includes
preparers and users. In 2002, IFRIC replaced the former Standing Interpretations
Committee (SIC) which had been created by the IASC. All of the SIC
Interpretations have been adopted by the IASB.
Other Relevant International
Organizations
2. IFRS Advisory Council (previously known as the Standards Advisory Council
‘SAC’)
A group of organizations and individuals with an interest in international
financial reporting. The Advisory Council’s role includes advising on priorities within
the IASB work program. The IASB is required to consult with the Advisory Council in
advance of any board decisions on major projects that it wishes to add to its
agenda.
3. International Federation of Accountants (IFAC)
A non-profit, non-governmental, non-political organization of
accountancy bodies that represents the worldwide accountancy profession. Its
mission is to develop and enhance the profession to provide services of
consistently high quality in the public interest.
Other Relevant International
Organizations
4. International Organization of Securities Commission (IOSCO)
An international body of security commissions. The Philippine SEC is a
member of IOSCO.
Move to IFRS
Prior to the full adoption of the IFRS in 2005, the accounting standards used in the
Philippines were previously based on US GAAP, i.e., the Statements of Financial
Accounting Standards issued by the Federal Accounting Standards Board
(FASB), the US national standard setting body.

The move to IFRSs was primarily brought about by the increasing acceptance of
IFRSs worldwide and increasing internationalization of businesses thereby
increasing the need for a common financial reporting standards to minimize, if
not eliminate, inconsistencies of financial reporting among nations.
The future of IFRS
A significant milestone towards achieving the goal of having one set of global
standards was reached in October 2002 when the FASB and IASB entered into a
memorandum of understanding called the “Norwalk Agreement”.
In this agreement, the FASB and the IASB formalized their commitment to the
convergence of US GAAP and IFRSs by agreeing to use their best efforts to:
a. Make their existing financial reporting standards fully compatible as soon as
practicable, i.e., minimize differences, and
b. Coordinate their future work programs to ensure that once achieved,
compatibility is maintained.
Changes in Reporting Standards
Once established, financial reporting standards are continually reviewed, revised
or superseded. Changes to reporting standards are primarily made in response
to users’ needs.
Users’ needs for financial information change, and so must financial reporting
standards in order to continually provide useful information.
Legal, political, business and social environments also influence changes in
reporting standards.
Regulatory bodies, lobbyists, laws and regulations, and changes in economic
environments affect the choice of accounting treatment provided under the
reporting standards.