LESSON 1

Introduction to the Course

and Accounting & its Environment

INTRODUCTION

This course provides an introduction to accounting, within the context of business and business
decisions. Students obtain basic understanding of the principles and concepts of accounting as
well as their applicability and relevance in the national context and learn how to use various types
of accounting information found in financial statements and annual reports. Emphasis is place on
understanding the reasons underlying basic accounting concepts and providing students with an
adequate background on the recording, classification and summarization functions of accounting
to enable them to appreciate the varied uses of accounting data.

This module is subdivided into two (2) units; Unit 1 will provide the overview of the course
requirements/course expectations; while unit 2 will focus on Accounting and its Environment.

LEARNING OUTCOMES
At the end of this module, the students are expected to:
– familiarize with the VMGO of the university and provide their expectations from the
course;
– define accounting and explain its role in business;
– have a fair knowledge of the evolution of accounting and find how it affected accounting
pedagogy, policy and practice;
– identify the different environments of business;
– compare the characteristics of different types of businesses;
– describe the various forms of business organizations;
– understand the effects of purposes of accounting in all phases of the enterprise;
– appreciate and understand the role of accounting and its criteria in analyzing business
transactions;
– learn the basic accounting terminology and principles;
– recognize the impact and value of accounting practices to the Philippine economy.

Page 1
UNIT 2 – ACCOUNTING & ITS ENVIRONMENT

Accounting is significant in all walks of life and is totally essential in the world of business. It is the
system that measures business activities, processes that information into reports and
communicates the results to decision – makers. Accounting quantifies business communication.
For this reason, accounting is called the language of business.

As business and society become more complex, accounting develops new concepts and
techniques to meet the ever – increasing needs for financial information, which without such
information, many complex economic developments and social programs may never have been
undertaken.

Without accounting, a business couldn’t function optimally; it wouldn’t where it stands financially,
whether it is making a profit or not, and eventually it wouldn’t know its financial situation.

2.1 Definitions and Scope 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
decision (Statement of Financial Accounting Standards No. 1, “Basic Concepts and Accounting
Principles Underlying Financial Statements of Business Enterprises.” (Manila: Accounting
Standards Council,1983), par.1).

Accounting is an information system that measures, processes and communicates financial

information about an economic entity (Statement of Financial Accounting Concepts No. 1,
“Objectives of Financial Reporting by Business Enterprises” (Norwalk, Conn.: Financial
Accounting Standards Board, 1978), par. 9).

Accounting is the process of identifying, measuring and communicating economic information to

permit informed judgments and decisions by users of the information (American Accounting
Association, “A Statement of Basic Accounting Theory” (Evanston, ill.: American Accounting
Association, 1966), par.1.

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, “Review and
Resume”, Accounting Terminology Bulletin No. 1 (New York: AICPA, 1953), par. 9).

2.2 Evolution of Accounting

Accounting history is important to accounting pedagogy, policy and practice. It makes it possible
to better understand our present and to forecast our future. Accounting history is the “study of the
evolution in accounting thought, practices and institutions in response to changes in the
environment and societal needs. It also considers the effect that this evolution has worked in the

Page 2
environment.” (Committee on Accounting History, Report of the Committee, Accounting Review,
sup. to Vol. XLV, 1920, p. 53).

Primitive Accounting –
The origin of keeping accounts has been traced as far back as 8500 B.C, the
date archaeologists have established for certain clay tokens – cones, disks, spheres &
pellets – found in Mesopotamia (modern Iraq). The tokens were often sealed in clay balls,
called bullae which were, in effect, the first bill of lading.

During the 1st dynasty of Babylonia, (2286 – 2242 B.C.), its law which was based on Code
of Hammurabi, requires merchants trading goods to give buyers a sealed memorandum
containing the agreed price before it can be considered enforceable. The agreed-upon
transaction was recorded by the Scribe (the predecessor of the modern accountant) on a
small mound of clay with the parties affixing their signatures on it. This clay was allowed
to dry & served as the record of the transaction. At 3600 B.C., in Babylonia, clay tablets
also recorded payments of wages.

Middle Ages –
The first treatise on the art of systematic bookkeeping appeared in 1494, in Venice.
A Franciscan monk, Fra Luca Pacioli, has been regarded as the father of double-entry
accounting. In the 17th century, Nicolas Petri was the first person to group similar
transactions in a separate record & enter the monthly totals in the journal, rather than
recording all transactions in a series.

Industrial Revolution & Corporate Organization – the need for accounting services
emerged slowly, but by the early decades of the 19th century, a flurry of textbooks &
handbooks on accounting has appeared, reflecting the impact of the Industrial Revolution.

Informative Age –
The advent of Internet along with its promising prospects of doing business Online
or E-commerce will surely bring about another metamorphosis in the fields of accounting.

2.3 Types of Business

Although the fundamental business model does not vary, there are infinite ways of applying it to
provide the range of products and services that make up the business world. However, the range
of products and services can be summarized in seven broad categories, they are as follows:

Type Activity Structure Examples

Services Selling people’s Hiring skilled staff Software development
time and selling their Accounting
time Legal

Page 3
Trader Buying and selling Buying a range of Wholesaler
products raw materials and Retailer
manufactured
goods and
consolidating them,
making them
available for sale in
location near to their
customers or online
for delivery

Manufacture Designing products, Taking raw Vehicle assembly

aggregating materials and using Constructions
components and equipment and staff Engineering
assembling finished to convert them into Electricity, water
products finished goods Food and drink
Chemicals
Media
Pharmaceuticals

Raw materials Growing or Buying blocks of Farming

extracting raw land and using them Mining
materials to provide raw Oil
materials
Infrastructure Selling the Buying and Transport (airport
utilization of operating assets operator, airlines, trains,
infrastructure (typically large ferries, buses)
assets); Hotels
selling occupancy Telecoms
often in combination Sports facilities
with services Property management

Financial Receiving deposits, Accepting cash from Bank

lending and depositors and Investment houses
investing money paying them
interest; using the
money to provide
loans to borrowers,
charging them fees
and a higher rate of
interest 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. By

Page 4
 understanding the
risk accepted and
the likelihood of a
claim, more
premium income
can be earned then
claims paid

2.4 Forms of Business Organizations

A business generally assumes one of the three forms of organization. The accounting
procedures depend on which form the organization takes.

Sole Proprietorship
This business organization has a single owner called the proprietor who generally
is also the manager. Sole proprietorships tend to be mall service-type businesses and
retail establishments. The owner receives all profits, absorbs all losses and is solely
responsible for all debts of the business. From the accounting point of view, the sole
proprietorship is distinct from its proprietor. Thus, the accounting records of the sole
proprietorship do not include the proprietor’s personal financial records.

Partnership
A partnership is a business owned and operated by two or more persons who bind
themselves to contribute money, property, or industry into a common fund, with the
intension of dividing profits among themselves. Each partner is personally liable for any
debt incurred by the partnership. Accounting considers the partnership as a separate
organization, distinct from the personal affairs of each partner.

Corporation
A corporation is a business owned by its stockholders. It is an artificial being
created by operation of law, having the rights of succession and the powers, attributes,
and properties expressly authorized by law or incidents to its existence. The stockholders
are not personally liable for the corporation’s debts. The corporation is a separate legal
entity.

2.5 Activities in Business Organization

Many types of decisions are made in business organizations. Accounting provides important
information to make these decisions. The three types of organizational activities are as follows:

Financing Activities
Organizations require financial resources to obtain other resources used to
produce goods and services. They compete for these resources in financial markets.
Financing activities are the methods an organization uses to obtain financial resources
from the financial markets and how it manages these resources. Primary sources of

Page 5
 financing for most businesses are owners and creditors, such as banks and suppliers.
Repaying the creditors and paying a return to the owners are also financing activities.

Investing Activities
Managers use capital from financing activities to acquire other resources used in
the transformation process – that is, to transform resources from one form to a different
form, which is more valuable, to meet the needs of the people. Having the right mix of
resources is essential to efficient and effective operations.

An efficient business is one that provides goods and services at low costsrelative
to their selling prices. An effective business is one that is successful in providing goods
and services demanded by the customers.

Investing activities involve the selection and management including disposal and
replacement of long – term resources that will be used to develop, produce, and sell goods
and services. Investing activities include buying land, equipment, buildings and other
resources that are needed in the operation of the business, and selling these resources
when they are no longer needed.

Operating Activities
Operating activities involve the use of resources to design, produce, distribute, and
market goods and services. Operating activities include research and development,
design and engineering, purchasing, human resources, production, distribution, marketing
and selling, and servicing. Organizations compete in supplier and labor markets for
resources used in these activities. Also, they compete in product markets to sell the goods
and services created by operating activities.

2.6 Purpose and Phases of Accounting

The accounting function is part of the broader business system, and does not operate in isolation.
Business transactions are the economic activities of a business. Accounts are produced to aid
management in planning, controlling and decision – making and to comply with regulations.

Recording
This deals with the writing of business transactions or events. Bookkeeping is the
systematic and chronological recording of business transactions or events in the books
of original entry called the general journal. It is said to be systematic because it is guided
by the Generally Accepted Accounting Principles and it is chronological because
transactions are recorded in the period of their occurrence.

Classifying
This deals with the sorting of accounts together. Accounts are classified as Assets,
Liabilities, Capital, Income and Expenses.

Summarizing

Page 6
 This deals with the preparation of financial statements such as Income Statement,
Balance Sheet, Statement of Changes in Owner’s Equity and Statement of Cash Flows.

Interpreting
This is the analytical phase of accounting evaluating the entity’s liquidity,
profitability and solvency.

2.7 Fundamental Concepts

Several fundamental concepts underlie the accounting process. The following should be
considered in recording business transactions:

Entity Concept
This is the most basic concept in accounting. An accounting entity is an
organization or a section of an organization that stands apart from other organizations and
individuals as a separate economic entity. The transactions of different entities should not
be accounted for together. Simply, each entity should be evaluated separately.

Periodicity Concept
For reporting purposes, an entity’s life can be meaningfully subdivided into equal
time periods. This concept allows the users to obtain timely information to serve as a basis
on making decisions about future activities. One year is the usual accounting period for
the purpose of reporting to outsiders.

Stable Monetary Unit Concept

The Philippine peso is a reasonable unit of measure and that its purchasing power
is relatively stable.

Going Concern
Financial statements are normally prepared on the assumption that the reporting
entity is a going concern and will continue in operation in the future. It is assumed that the
entity has neither the intention nor the need to enter liquidation or to cease trading. This
assumption underlies the depreciation of assets over their useful life.

2.8 Criteria for General Acceptance of an Accounting Principle

Accounting practices follow certain guidelines. Generally Accepted Accounting Principles

(GAAP), encompasses the conventions, rules and procedures necessary to define accepted
accounting practice at a particular time. The general acceptance of an accounting principle usually
depends on how well it meets three criteria: relevance, objectivity and feasibility.

A principle has relevance to the extent that it results in information that is meaningful and useful
to those who need to know something about a certain organization.

Page 7
A principle has objectivity to the extent that the resulting information is not influenced by the
personal bias or judgment of those who furnish it. Objectivity connotes reliability and
trustworthiness. It also connotes verifiability which means that there is some way of finding out
whether the information is correct.

A principle has feasibility to the extent that it can be implemented without undue complexity or
cost.

2.9 Basic Principles

The following principles are relied on in order to generate information that is useful to the users
of financial statements:

Objectivity Principle
Accounting records and statement are based on the most reliable data available
so that they will be as accurate and as useful as possible. Reliable data are verifiable
when they can be confirmed by independent observers. Accounting records are based
on information that flows from activities documented by objective evidence. Without this
principle, accounting records would be based on whims and opinions and is therefore
subject to disputes.

Historical Cost
This principle states that acquired assets should be recorded at their actual cost
and not at what management thinks they are worth as at reporting date.

Revenue Recognition Principle

Revenue is to be recognized in the accounting period when goods are delivered
or services are rendered or performed.

Expense Recognition Principle

Expenses should be recognized in the accounting period in which goods and
services are used up to produce revenue and not when the entity pays for those goods
and services.

Adequate Disclosure
This requires that all relevant information that would affect the user’sunderstanding
and assessment of the accounting entity be disclosed in the financial statements.

Materiality
Financial reporting is only concerned with information that is significant enough to
affect evaluations and decisions. Materiality depends on the size and nature of the item
judged in the particular circumstances of its omission. In deciding whether an item or an
aggregate of items is material, the nature and size of the item are evaluated together.

Page 8
 Depending on the circumstances, either the nature or the size of the item could be the
determining factor.

Consistency Principles
The firms should use the same accounting method from period to period to achieve
comparability over time within a single enterprise. However, changes are permitted if
justifiable and disclosed in the financial statement.

2.10 Branches of Accounting

The main branches of accounting and their brief descriptions are as follows:

Auditing
It is the accountancy profession’s most significant service to the public. Anexternal
audit is the independent examination that ensures the fairness and reliability of the reports
that management submits to users outside the business entity. The result of the
examinations is embodied in the independent auditor’s report. Once the required financial
statements have been prepared by the management, they have to be evaluated in order
to ensure that they do not present a misleading picture.

The external auditor’s job is to protect the interests of the users of the financial
statements. By contrast, internal auditors are employees of the company. They ensure the
accuracy of business records, uncover internal control problems and identify operational
difficulties. Internal auditors perform routine tasks and undertake detailed checking of the
company’s accounting procedures, whereas external auditors are likelyto go in for much
more selective testing.

Bookkeeping
It is a mechanical task involving the collection of basic financial data. The data are
first entered in the accounting records or the books of accounts, and then extracted,
classified and summarized in the form of income statement, balance sheet and cash flows
statement.

An income statement shows whether the business has made a profit or loss during
the period; it measures how well the business has done. A balance sheet lists what the
entity owns (its assets), and what it owes (its liabilities) as at the end of the period. The
cash flows statement presents the cash inflows and outflows of the business during the
period.

Cost Bookkeeping, Costing, and Cost Accounting

Cost Bookkeeping is the process that involves the recording of cost data in books
of accounts. It is similar to bookkeeping, except that the data are recorded in very much
greater detail. Use of the term “costing” is discouraged unless it is qualified in some way;
by referring to some branch of costing such as standard costing.

Page 9
 Cost accounting system contains a great deal more data, and thus once the data
are summarized there is much more information available to the management of the
company. It deals with the collection, allocation, and control of cost of producing specific
goods and services. Cost accounting forms one of the main sub branches of management
accounting.

Financial Accounting
It is focused on the recording of business transactions and the periodic preparation
of reports on financial position and results of operations.

Financial Management
It is a relatively new branch of accounting that has grown rapidly over the last 30
years. Financial managers are responsible for setting financial objectives, making plans
based on those objectives, obtaining the finance needed to achieve the plans, and
generally safeguarding all the financial resources of the entity.

Management Accounting
It incorporates cost accounting data and adapts them for specific decisions which
management may be called upon to make. A management accounting system
incorporates all types of financial and non- financial information from a wide range of
sources.

Taxation
Tax accounting includes the preparation of tax returns and the consideration of the
tax consequences of proposed business transaction or alternative courses of action.

Government Accounting
It is concerned with the identification of the sources and uses of resources
consistent with the provisions of city, municipal, provincial or national laws. The
government collects and spends huge amount of public funds annually so it is necessary
that there is proper custody and disposition of these funds.

Page 10