BASIC ACCOUNTING

BICOL UNIVERSITY
College of Business, Economics and Management
Department of Accountancy
Module 01: The Accounting Cycle
This module should help the students:

1. EXPLAIN what ACCOUNTING is.

2. IDENTIFY the USERS and USES OF ACCOUNTING.
3. UNDERSTAND why ETHICS is a fundamental business concept.
4. EXPLAIN the meaning of GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
and the COST PRINCIPLE.
5. EXPLAIN the meaning of the MONETARY UNIT ASSUMPTION and the
ECONOMIC ENTITY ASSUMPTION.
6. STATE the BASIC ACCOUNTING EQUATION and explain the meaning of
ASSETS, LIABILITIES, and OWNER’S EQUITY.
7. ANALYZE the effect of BUSINESS TRANSACTIONS on the basic accounting
equation.

Discussion:
What is accounting?

Accounting is an information system that identifies, records, and communicates

the economic events of an organization to interested users.
a. The first part of the process, identifying, involves selecting those events
that are considered evidence of economic activity relevant to a particular
business organization.
b. Recording is the keeping of a chronological diary of events, measured in
dollars and cents.
c. Communication occurs through the preparation and distribution of
accounting reports.
Bookkeeping is NOT the same as accounting. Bookkeeping involves only the
recording of economic events, while accounting also includes identification,
recording, and communication. Bookkeeping is therefore only a part of accounting.

Accounting is also divided into financial versus managerial accounting. Financial

accounting is the field of accounting that provides economic and financial
information for investors, creditors, and other external users. Managerial
accounting provides economic and financial information for managers and other
internal users

Why do we need accounting?

It is often said that accounting is the language of business. This is because the
primary purpose of accounting is to provide information about a business
organization to decision makers.

Focusing on this purpose, accounting is basically the bridge between the business
organization and the various decision makers.

The Business and

its activities Decision Makers

Accounting Information

The Business Organization

A business organization is a group of individuals who come together to pursue a

common set of goals and objective. The most common of these goals is to turn up a
profit by either:

1. Providing services to clients (security agencies, law firms, clinics, barbershops)

2. Buying and selling goods to consumers (department stores, hardware shops,

supermarkets, pharmacies)

3. Manufacturing goods from raw materials into finished products (factories)

4. Any combination of the above

In order to achieve that objective, the business needs accounting information

to make informed decisions.
A business may be organized as a proprietorship, partnership, or corporation.

a. A proprietorship is a business owned by one person.

b. A partnership is a business owned by two or more persons associated as

partners.

c. A corporation is a business organized as a separate legal entity under state

corporation law with ownership divided into transferable shares of stock.

Users of Financial Information – the Decision Makers

The decision makers may either be INTERNAL users or EXTERNAL users of financial
information.

Internal users of accounting information are its employees and managers who
plan, organize, and run the business. These include marketing managers,
production supervisors, finance directors, and company officers. They primarily rely
on information provided by managerial accounting, reports that are customized for
the need of internal users.
Internal user of Information they need about the business
information
Employee Will the company be able to pay our salaries and wages?
Are we eligible for bonuses this year?
Production Manager Did we meet our production quota for this month?
How much of this product did we manufacture for this month? How much
do we still have in stock in the warehouse?
Purchasing Manager What items, supplies, or equipment do we need to buy?
Sales Manager Did we meet our sales quota for this month?
What products and services do we sell the most?
Marketing Manager What price is the most suitable for our product?
Human Resource Manager How much did we pay our people this year?
Can we afford to increase the salary of the employees?
Top Management (CEOs, CFOs, Did the business do well this year? Where did we succeed/fail?
Company President, etc.) Do we need extra cash to finance our projects this year?
Can we payout dividends to our investors? Can we pay our debt and
loans that are still outstanding?
Meanwhile, external users of financial information include investors, creditors,
taxing authorities, regulatory agencies, labor unions, customers, economic
planners, and the general public outside the business. They rely on the generally
published financial statements of the company, as a product of financial accounting.
External user of Information they need about the business
information
Banks and other creditors Will the company be able to pay their outstanding debt and loans?
Will they need additional financing from us?
Suppliers and vendors Will the company be able to settle their outstanding balances on time?
Owners, stockholders, and other Did the company perform well and earn money?
investors Can we expect to receive dividends and returns on our investment?
Government and regulatory agencies Is the company properly reporting and paying their taxes?
Labor Unions Is the company properly compensating their employees?
Customers Will the company be able to continue providing goods and services in the
near future or is it going out of business?

In this course, you are treated as a

BEING A STUDENT, WHAT TYPE OF potential EXTERNAL user. That’s why
FINANCIAL INFORMATION USER ARE YOU? we are going to focus more on the
financial accounting and reporting
process.

Ethics in Accounting

The standards of conduct by which one's actions are judged as right or wrong,
honest or dishonest, fair or not fair, are ethics. The process of analyzing ethical
issues is to recognize that an ethical issue is involved, identify and analyze the
principle elements in the situation (especially those harmed or benefited), identify
the alternatives and weigh the impact of each alternative on the various
stakeholders, then select the most ethical alternative.

Since people rely on accounting information to make decisions, those involved in

the accounting process should NOT deliberately deceive, misinform, mislead,
confuse, or otherwise disable the ability of the users of information to make
informed choices.

Generally Accepted Accounting Principles (GAAP)

Generally accepted accounting principles (GAAP) are a common set of guidelines

(standards) used by accountants in reporting economic events.

The Philippine Financial Reporti ng Standard Council (PFRSC) has been granted the
power from the R.A. 9298 thru Philippine Professional Regulation Commission (PRC)
Board of Accountancy (BOA) to establish GAAP.

The Securities and Exchange Commission (SEC) is an independent regulatory

agency of the government. The SEC has the legal power to enforce the form and
content of financial statements of corporations that wish to sell securities to the
public.

Key Concepts under GAAP

Under the cost principle, assets should be recorded at their cost. Cost is the value
exchanged at the time something is acquired.

The monetary unit assumption requires that only transaction data that can be
expressed in terms of money be included in the accounting records.

The economic entity assumption requires that the activities of the entity be kept
separate and distinct from (1) the activities of its owner and (2) all other economic
entities. Simply, the business is a SEPARATE and DISTINCT from its owner.

The Accounting Equation

The basic accounting equation is:

Assets = Liabilities + Owner's Equity.

The accounting equation applies to all economic entities regardless of size, nature
of business, or form of business organization.

The key components of the basic accounting equation are:

a. Assets are resources controlled (not necessarily owned) by a business
that are necessary for the conduct of its activities.
b. Liabilities are claims against assets. These represent obligations that are
owed to third parties in the form of loans, payables, etc.
c. Owner's equity is the residual claims of owners against the assets. This
represents the remaining portion of the business that is retained by the
owner after the assets are used to settle the liabilities.
To understand this a little better, let’s consider that you want to create your own
business, i.e. a computer shop. In order to start the business, you would need
cash, a couple of computer units, chairs, internet connection, business space, and
other necessary equipment. These resources are the ASSETS of your business.

If you personally have the needed assets for your business, then you can right
away invest those assets into the business enterprise. By investing into the
business, you, as the owner now has a claim over the assets of the business. This
claim is the OWNER’S EQUITY.

IF you don’t personally have the needed assets, then you can borrow money from a
bank to buy the assets. The act of borrowing creates an obligation to a third party,
that is the obligation to pay back the money owed. This obligation is the LIABILITY.

So, in order to have assets in your business, you could either OWN (owner’s equity)
them already, or you could BORROW (liabilities) from other parties.

To summarize, look at the accounting equation again:

Assets = Liabilities + Owner's Equity.

RESOURCES Borrowed Owned

SOURCES of the RESOURCES

In proprietorships, there are four subdivisions of owner's equity:

a. Investments by Owner / Capital are the assets put in the business by
the owner.
b. Revenues are the gross increases in owner's equity resulting from
business activities entered into for the purpose of earning income.
c. Drawings are withdrawals of cash or other assets by the owner for
personal use.
d. Expenses are the cost of assets consumed or services used in the process
of earning revenue.

An expanded form of the accounting equation can be expressed as:

ASSETS = LIABILITIES + OWNER'S CAPITAL - OWNER'S DRAWING + REVENUES –

EXPENSES

Revenues and expenses determine if a net income or net loss occurs as follows:
a. Revenues > Expenses = Net Income.
b. Revenues < Expenses = Net Loss.

Transactions
Transactions are the economic events of the enterprise recorded. Each transaction
must be analyzed in terms of its effect on the components of the basic accounting
equation. The analysis must also identify the specific items affected and the
amount of the change in each item.

Each transaction has a dual effect on the equation. For example, if an individual
asset is increased, there must be a corresponding:
a. decrease in another asset, or
b. increase in a specific liability, or
c. increase in owner's equity.

A tabular summary may be prepared to show the cumulative effect of transactions

on the basic accounting equation. The summary demonstrates that:
a. Each transaction must be analyzed in terms of its effect on (1) the
three components of the equation and (2) specific types of items
within each component.
b. The two sides of the equation must always be equal.
c. The causes of each change in the owner's claim on assets must be
indicated in the owners' equity column.