ACCOUNTING FUNDAMENTALS

CHAPTER 1

The World of Accounting

Learning Objectives:

After studying this chapter, you should be able to:

1. Define accounting and explain its role in business.

2. Have a fair knowledge of the evaluation of accounting and find how it affected accounting pedagogy,
policy and practice.

3. Ascertain the need to adapt Fra Luca Pacioli's system for the modern times.

4. Discuss the basics of ASEAN and recognize how it will affect the professionals in the region.

5. Explain the need for non-accountants to study accounting.

6. Narrate briefly the development of accountancy in the Philippines and describe the attributes that
makes it a profession including the scope of its practice.

7. Summarize the salient features of the Code of Ethics for Professional accountants.

8. Explain the role of ethics in business.

9. Recount the accounting standard-setting bodies.

10. Identify and discuss the career opportunities open to accountants.

INTRODUCTION

The word account in everyday language is often used as a substitute for an explanation or a report of
certain actions or events. If you are an employee, for example, you may have to explain to your
employer just how you have been spending your time, or if you are a manager, you may have to report
to the owner on how the business is doing. In order to explain or to report, you, of course, have to
remember what you were doing or what happened. As it is not always-easy to remember, you many
need to keep some written record. In effect, such records can be said to form the basis of a rudimentary
accounting (or reporting) system.

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ACCOUNTING FUNDAMENTALS

Accounting has evolved, as in the case of medicine and law, in response to the social and economic
needs of society. As business and society become more complex, accounting develops new concepts
and techniques to meet the ever-increasing needs for financial information. Without such information,
many complex economic developments and social programs may never have been undertaken.

In a market economy, information helps decision-makers make informed choices regarding the
allocation of scarce resources under their control. When decision-makers are able to make well-
informed decisions, resources are allocated in a way that better meets the needs and goals of those
within the market.

Accounting is relevant in all walks of life, and it is absolutely essential in the world of business.
Accounting is the system that measures business activities, processes that information into reports and
communicates the results to decision-makers. For this reason, accounting is called the language of
business.

DEFINITIONS 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 used making economic decisions (Statement of
Financial Accounting Standards No. 1 Concepts and Accounting Principles Underlying Financial
Statements of Business Entrep (Manila: Accounting Standards Council, 1983), 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).

EVOLUTION OF ACCOUNTING

“If you would understand anything, observe its beginning and its
development."
--Aristotle

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.

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ACCOUNTING FUNDAMENTALS

Primitive Accounting

People have counted and kept records throughout history. 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 and pellets-found "in Mesopotamia (modern Iraq). These tokens represented such
commodities as sheep, jugs of oil, bread or clothing and were used in the Middle East to keep records.

The presence of bookkeeping in the ancient world has been attributed to various factors including (i) the
invention of writing: (ii) the introduction of Arabic numerals; (in) the decimal system; (iv) the diffusion of
knowledge of algebra; (v) the presence of inexpensive writing materials; (vi) the rise of literacy; and (vii)
the existence of a standard medium of exchange. A.C Littleton in Accounting Evolution to 1900 lists
preconditions for the emergence of systematic bookkeeping:

The Art of Writing, since bookkeeping is first of all a record; Arithmetic, since the mechanical
aspect of bookkeeping consists of a sequence of simple computations;

Private Property, since bookkeeping is concerned only with recording the facts about property
and property rights. Credit (e uncompleted transactions), since there would be little impulse to
make any record whatever if all exchanges were completed on spot; Commerce, since a merely
local trade would never have created enough pressure (volume of business) to stimulate men to
coordinate diverse ideas into a system; Capital, since without capital commerce would be trivial
and credit would be inconceivable.

Middle Ages

As a result of the Crusades from the 11th to the 13th centuries, Northern Italy's literacy has become
widespread. Arabic numerals were also being used as a result of trade with the Near East allowing
columns of numbers to be added and subtracted.

The Inca Empire, which spanned the west coast of South America throughout the 11th to 14th centuries,
used knotted cords of different lengths and colors called quipu to keep accounting records.

Development of more formal account-keeping methods is attributed to the merchants and bankers of
Florence, Venice and Genoa during the 13th to 15 th centuries.

Double-entry bookkeeping is not a discovery of science; It is the outcome of continued efforts to meet
the changing necessities of trade. German philosopher Oswald Spengler wrote in The Decline of the

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ACCOUNTING FUNDAMENTALS

West (1928) that the invention of double-entry bookkeeping was the decisive event in European
economic history.

The Florentine Approach

Renaissance Florentine markets were a fascinating combination of formalization, in the form of account
books and double-entry bookkeeping, and of informal social networks, constructed out of the
surrounding rules of Florentine sociality. To them, doing business and living life were extensions of each
other. Business was conducted on logic of friendship, but friendship in turn was instrumental, as well as
emotional, Account books were not inconsistent with social exchange; rather, they formalized and
made social exchange easier. The explosion of commercial credit, at that time, required a system of
recording.

Amotino Manucci was the inventor of double-entry bookkeeping. He managed to construct a

comprehensive and fully-articulated set of double-entry records, with a regular balancing procedure on
closure of the General Ledger. He used five books-general ledger, two merchandise ledgers, expenses
ledger, and cash book (with the white ledger as a sixth)-constituted what looks very like a true double-
entry system. In addition, there were at least two subsidiary books. He gave importance to the aspect of
financial control.

The Method of Venice

Luca Pacioli, a Franciscan friar and a celebrated mathematician, is generally associated with the
introduction of double-entry bookkeeping In 1494 he published his book, Summa de Arithmetica,
Geometria, Proportioni et Proportionalita or "Everything about Arithmetic, Geometry, Proportions and
Proportionality," which includes, Particularis de Computis et Scripturis or "Details of Calculation and
Recording," describing double-entry bookkeeping. His treatise reflected the practices of Venice at the
time, which became known as the Method of Venice or the Italian method. Therefore, he did not invent
double-entry bookkeeping, but rather described what were prevalent accounting practices of the day.
Although Pacioli made no claim to developing the art of bookkeeping, he has been regarded as the
father of double-entry accounting. He stated that the purpose of bookkeeping was "to give the trader
without delay information as to his assets and liabilities." Pacioli also advised the computation of a
periodic profit and the closing of the books. He said, "It is always good to close the books each year,
especially if you are in a partnership with others. Frequent accounting makes for long friendship"

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ACCOUNTING FUNDAMENTALS

Savary and Napoleonic Commercial Code

The earliest systematized form of accounting regulation developed in continental Europe, starting in
France in 1673. The government introduced the submission of an annual fair value statement of
financial position to protect the economy from bankruptcies

This legal requirement for businesses to keep accounting records was first Introduced in the
Ordonnance de Commerce of 1673 which was put through by jean-Baptiste Colbert during the reign of
Louis XIV, and the Napoleonic Commercial Code of 1807, that influenced the bookkeeping provisions of
commercial law throughout Continental Europe, Francophone Africa, and beyond.

The Napoleonic Code or Code Napoléon is the French civil code, established under Napoléon Bonaparte
on Mar. 21, 1804, The Commercial Code was adopted in 1807.

Jacques Savary, the elder (1622-1690) in an early accounting text stated, "If this merchandise is starting
to deteriorate, or go out of style, or is that which one judges he could find at the factory or wholesalers
at 5% less, it must be reduced to this price." Although this is the oldest known formulation of the lower
of-cost-or: market principle, Vance reported that several earlier accounting texts recommended current
cost rather than historical cost valuation of inventory in specific examples where the market valuation
was lower, Inventory valuation at the lower-of-cost-or-market was required by the Code of Commerce in
France in 1673, in Prussia in 1794 (Vance, 1943), and in the German Commercial Code of 1884
(Schmalenbach, 1959, p. 17). Commercial Code of 1673 was also called the Code Savary.

In the 17th century, Nicolas Petri was the first person to group similar transactions in a separate record
and enter the monthly totals in the journal, rather than recording all transactions seriatim, that is, in a
series.

In 1769, Benjamin Workman published The American Accountant, the earliest- known American
accounting textbook.

Industrial Revolution, Corporate Organization, Railroads, United States Steel

Accounting practice really dates from antiquity, but the formation of an accounting was closely tied to
the rise of a modern industrial society in Britain during the late 18th century. The need for accounting
services emerged slowly, but by the early decades of the 19th century a flurry of textbooks and
handbooks on accounting had appeared, reflecting the impact of the Industrial Revolution.

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ACCOUNTING FUNDAMENTALS

This revolution, which occurred in England from the mid-18th to the mid-19 th century, changed the
method of producing commercial goods from the handicraft method to the factory system. With this
change came the problem of costing for a large volume of products.

Schmalenbach and. The Model Chart of Accounts

Eugen Schmalenbach (1873-1955) was a German academic and economist. He was born in Halver, and
attended the Leipzig College of Commerce starting in 1898. Schmalenbach was a professor at the
University of Cologne and as a contributor to German language journals on the subject of economics,
business management and financial accounting.

Pacioli's Double-Entry Bookkeeping

Modern bookkeeping systems are still based on principles established in the 15 th century, although they
have had to be adapted to suit modern conditions.

Why has a recording system devised in medieval times lasted for so long? There are two main reasons:

1. it provides an accurate record of what has happened to a business over a specified period of
time; and
2. Information extracted from the system can help the owner or the manager aperate the business
much more effectively.

In essence, the system provides the answers to three basic questions which owners want to know:

1. What profit has the business made?

2. How much does the business owe?

3. How much is owed to it?

As a result, Pacioli's system had to be adapted for modern business practice so that it can satisfy the
demand for information from two main sources:

1. From owners, who want to know from time to time how the business is doing and

2. From the managers, who need information in order to help plan and control it.

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ACCOUNTING FUNDAMENTALS

Owners and managers do not necessarily require the same information and so based on this accounting
has developed into two main specializations:

1. Financial Accounting, which is concerned with the supply of information to the owners of an entity;
and

2. Management Accounting which is concerned with the supply of information to the managers of an
entity.

While it is useful to classify acounting into these two broad categories, accountants are now involved in
supplying information to a wide range of other interested parties, such as customers, employees,
governments and their agencies, investors, lenders, the public and suppliers and other trade creditors.

ASEAN

Establishment and Member States

The Association of Southeast Asian Nations, or ASEAN, was established on Aug. 8, 1967 in Bangkok,
Thailand, with the signing of the ASEAN Declaration (Bangkok Declaration) by the Founding Fathers of
ASEAN, namely: Indonesia, Malaysia, Philippines, Singapore and Thailand. Brunei Darussalam then
joined on Jan. 7, 1984, Viet Nam on July 28, 1995, Lao PDR and Myanmar on July 23, 1997 and Cambodia
on Apr. 30, 1999, making up what is today the ten Member States of ASEAN.

Vision

In a nutshell, the Vision: "a stable, prosperous and highly competitive ASEAN Economic Region in which
there is a free flow of goods, services, investment and a freer flow of capital, equitable economic
development and reduced poverty and socio-economic disparities."

Opportunities

What are the opportunities? Ten member states with a 2013 population of 625 million. ASEAN is
characterized by rising incomes, young population, with combined gross domestic product (GDP) at
current prices of US$Z,399 billion or a GDP per capita at current prices of US$3,839 and GDP growth rate
of 5.1.

Four Pillars of ASEAN Economic Community

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ACCOUNTING FUNDAMENTALS

The ASEAN Community is comprised of three pillars, namely; the ASEAN Political- Security Community,
ASEAN Economic Community and ASEAN Socio-Cultural Community.

ASEAN Framework Agreement on Services

ASEAN is a government-to-government cooperation. To realize its dreams, ASEAN has progressively

entered into more legally binding and institutionalized agreements through the adoption of the ASEAN
Trade in Goods Agreement (ATIGA), the ASEAN Comprehensive Investment Agreement (ACIA) and the
ASEAN Framework Agreement on Services (AFAS). AFAS aims to provide greater mobility of ASEAN
professionals to provide their services in the region. This will require rounds of negotiations to liberalize
trade in services.

Mutual Recognition Arrangements and ASEAN Chartered Professional Accountant

MRAS (mutual recognition arrangements) are contracts between a National Accountancy Body (NAB)
and/or Professional Regulatory Authority (PRA) from countries that have signed the General Agreement
on Trade in Services in 1995 allowing professional service providers registered in signatory countries to
be equally recognized in another signatory country. The existing MRAS: for engineering (MRA 2005),
nursing (MRA 2006), architectural (MRA 2007), medical (MRA 2009), dental (MRA 2009), accountancy
(MRA 2014) and surveying (MRA Framework 2009) services.

ACCOUNTING AND THE NON-ACCOUNTANT

Whatever your job, whether you repair machines in a factory, teach children in a school, or nurse sick
patients in a hospital, you probably feel that you seem to spend all your time filling in forms and reading
reports. Why? Why can't you just go on with your job?

It is true that in many organizations there is now a large proportion of paperwork. It can get out of hand,
but usually there is a reason behind it all. A great deal of information that is collected may, for example,
be required by law. Some entities have a statutory obligation to publish, Le. to make available for public
Inspection, a certain amount of information about their affairs. This process requires a considerable
amount of material to be collected about an entity's activities before it can be summarized in a form
suitable for publication. In the previous section, we referred to this process as financial accounting. As a
manager, it may be somewhat tiresome for you to be become involved in financial accounting, but if the
entity is to comply with the law you have no option.

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ACCOUNTING FUNDAMENTALS

ROLE OF ETHICS IN BUSINESS

Definition

Ethics is concerned with right and wrong and how conduct should be judged to be good or bad. It is
about how we should live our lives and, in particular, how we should behave towards other people. It is
therefore relevant to all forms of human activity. Business ethics tells what is right or wrong in a
business situation, while professional ethics tells the same thing regarding a profession. Ethical conflicts
can arise, however, when what might be best for the entity is wrong morally or professionally.

Ethical Dilemma

Ethical dilemma, by definition, is a situation in which there is no obvious right or wrong decision but
rather a right right answer. Ethical dilemmas because its primary purpose is to make a

Business is a good source profit. It is a constant search for potential advantage over others such that
businessmen are under pressure to do whatever yields such advantage. It is fundamental that business
consciously apply ethical rules in its decision process to avoid potentially undesirable situations.

BRANCHES OF ACCOUNTING

The work that accountants now undertake ranges far beyond that of simply summarizing information in
order to calculate how much profit a business has made, how much it owes, and how much is owed to
it. Although this work is still very important, accountants have gradually got involved in other types of
work. Of course, other information specialists (such as market researchers and operational analysts)
have also been drawn into the preparation of management information, and at one time, some
observers expected accounting to be taken over by these newer and more scientifically-based
disciplines. However, this has not happened. There are three main reasons

1. Financial information supply to external users still has a dominant influence on internal
management information;

2. Other information specialists have been reluctant to become invalved in detailed accounting
matters; and

3. Accountants have been quick to absorb new methods and techniques into their work.

The main branches of accounting and their brief descriptions are discussed below.

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ACCOUNTING FUNDAMENTALS

Accountancy and Accounting

Accountancy is a profession whose members are engaged in the collection of financial data, the
summary of that data, and then the presentation of information in a form which helps recipients take
effective decisions. Many writers use accountancy and "accounting as synonymous terms, but in this
book, "accountancy to describe the profession, and the term accounting to refer to the subject. we shall
use the term

Auditing

Auditing forms a most important branch of accountancy. Once accounts have been prepared, they may
have to be checked in order to ensure that they do not present a distorted picture. The checking of
accounts and the reporting on them is known as auditing. Businesses have their accounts audited as a
legal requirement.

Bookkeeping

Bookkeeping is a mechanical task involving the collection of basic financial data. The data are first
entered in special records known as books of account, and then extracted and summarized in the form
of a profit and loss account and a balance sheet. This process normally takes place once a year, but it
may occur more frequently. A profit and loss account shows whether the business has made a profit or
loss during the year, i.e. 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 year.

Cost Bookkeeping, Costing, and Cost Accounting

Cost bookkeeping is the process that involves the recording of cost data in books of account. It is,
therefore, similar to bookkeeping except that data are recorded in very much greater detail. Cost
accounting makes use of those data once they have been extracted from the cost books in providing
information for managerial planning and control. Accountants are now discouraged from using the term
'costing unless it 5 qualified in some way, L.e. by referring to some branch of costing (such as standard
costing), but even so you will Still find the term 'costing in general use.

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ACCOUNTING FUNDAMENTALS

Financial Accounting

Financial accounting is the more specific term applied to the preparation and subsequent publication of
highly summarized financial information. The information supplied is usually for the benefit of the
owners of an entity, but it can also be used by management for planning and control purposes. It will
also be of interest to other parties, e.g. employees and creditors.

Financial Management

Financial management 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. Financial managers are much more heavily involved in the management
of the entity than is generally the case with either financial or management accountants. It should also
be noted that the financial manager draws on a much wider range of disciplines (such as economics and
mathematics) and relies more extensively on non-financial data than does the more traditional
accountant.

Management Accounting

Management accounting 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

Taxation is a highly complex technical branch of accounting. Accountants involved in tax work are
responsible for computing the amount of tax payable by both business entities and individuals. It is not
necessary for either companies or individuals to pay more tax than is lawfully due, and so it is quite in
order for them to minimize the amount of tax payable. If tax experts attempt to reduce their clients' tax
liabilities strictly in accordance with the law, this is known as 'tax avoidance'. Tax avoidance is a perfectly
legitimate exercise, but tax evasion (the non-declaration of sources of income on which tax might be
due) is a very serious offense. In practice, the borderline between tax avoidance and tax evasion can
sometimes be a fairly narrow one.

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ACCOUNTING FUNDAMENTALS

Other Aspects

The main branches of accounting described above cannot always be put into such neat categories.
Accountants in practice (that is, those who work from an office and offer their services to the public)
usually specialize in auditing, financial accounting or taxation. Most accountants working in commerce,
industry or the public sector will be employed as management accountants, although some may deal
specifically with auditing, financial accounting, or taxation matters.

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