ACCOUNTING: The Language of Business

THE COINING OF A PHRASE

The phrase "accounting is the language of business" is attributed to Warren Edward Buffet, the
chairman and CEO of Berkshire Hathaway, as he gave advice to a 17-year-old investment intern
during a CNBC interview and phone call.
Buffet counseled the young man to study accounting language because it was the best way to
learn how to read financial statements.
As with any foreign language, Buffet suggested it takes time to get all the basics down and
integrated into one's understanding and usage, but is ultimately a main factor toward success in
the business world.
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 USEFUL IN MAKING ECONOMIC DECISIONS.
( Accounting Standards Council )
 Accounting is an INFORMATION system that MEASURES, PROCESSES and
COMMUNICATES FINANCIAL INFORMATION about an economic entity.
( Financial Accounting Standards Board )
 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 )
 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
results thereof.
( American Institute of CPAs )
PHASES of ACCOUNTING
MEASURING
The accountant must consider the recognition issue, valuation issue and classification issue.
RECORDING
The accountant must record the measurable transactions.
SUMMARIZING
The effects of all business transactions that occurred during some period must be summarized.
INTERPRETING
Results must be interpreted or analyzed to provide decision-makers with information to make
reasoned choices.
USERS AND THEIR INFORMATION NEEDS
EXTERNAL USERS – individuals and others that have current or potential financial interest in
the reporting entity but are not involved in the daily operations of the entity.
PRIMARY EXTERNAL USERS
USER INFORMATION NEEDS
Existing and Potential Investors Information whether they should invest, hold or
sell.
Lenders or Creditors (such as Information that enables them to determine
banks, cooperatives, finance whether their loans and the related interest will
companies) be paid when due.

Suppliers and Other Trade Creditors Information that enables them to determine
whether amounts owing them will be paid when
due.

OTHER EXTERNAL USERS

USER INFORMATION NEEDS
Employees Stability and profitability of their employers;
information which enables assessment of
the ability of an enterprise to provide
remuneration, retirement benefits and
employment opportunities
Customers Continuance of an enterprise, especially when
they have a long-term involvement
with, or are dependent on, the enterprise
Government and their Agencies Allocation of resources and the activities of the
enterprise; information to regulate
the activities of the enterprise, to determine
taxation policies and to become a basis
for national income and similar statistics
Public Trends and developments in the prosperity of
the enterprise and the range of its activities

BRANCHES OF ACCOUNTING
 Auditing
The most significant service to the public.
As defined by the American Accounting Association,
“Auditing is a systematic process by which a competent, independent person objectively obtains
and evaluates evidence regarding assertions about economic actions and events to ascertain the
degree of correspondence between those assertions and established criteria and communicating
the results to interested users.
 Bookkeeping
The mechanical task involving the collection of basic financial data.
Bookkeeping Vs. Accounting
Bookkeeping is a routine operation, while accounting requires the ability to examine a problem
both financial and non-financial data.
  Cost Bookkeeping, Costing and Cost Accounting
The process that involves the recording of cost data in books of accounts.
Cost accounting is the collection, allocation, and control of the costs to produce or supply a
product or service.
 Financial Accounting
The process of developing general-purpose financial statements and reporting general-purpose
accounting information to various external users.
 Financial Management
The planning, organizing, directing and controlling of financial activities such as procurement
and utilization of funds of the enterprise.
Functions of Financial Manager
1. Raising capital to support the organization’s operations and investments.
2. Managing the day-to-day cash flows.
3. Selecting the best projects to invest in.
4. Managing the entity’s exposure risk.
5. Developing a governance structure capable of ensuring that managers act
ethically and in, the owners’ interests.
 Management Accounting
Incorporates cost accounting data and adapts them for specific decisions which management may
be called upon to make.
This is the process of identification, measurement, accumulation, analysis, preparation,
interpretation and communication of information used by management to plan, evaluate and
control within an entity and to assure appropriate use of and accountability for its resources. ( -
CIMA)
 Taxation
Includes the preparation of tax returns and the consideration of the tax consequences of proposed
business transactions or alternative courses of action.
 Government Accounting
Concerned with the identification of the sources and uses of resources consistent with the
provisions of city, municipal, provincial or national laws.
 Accounting Education
Its primary goal is to produce competent professional accountants capable of making a positive
contribution over their lifetime to the profession and society in which they work.
 Accountancy Research
This is the systematic process of collecting and analyzing information to increase one’s
understanding of the functions of a professional accountant and contribute to the solution of
problems besetting the practice of the profession.
 Forensic Accounting
This is also called as fraud examination. This includes fraud detection, fraud prevention,
litigation support, business valuations, expert witness service and other investigative services.

 International Accounting
This is the study of standards, guidelines and rules of accounting, auditing taxation that exist
within each country as well as comparison of those items across countries.

FUNDAMENTAL CONCEPTS
In recording business transactions, accountants should consider the following:
 Entity Concept – each accounting entity is accounted for or evaluated separately,
including its owner
 Periodicity Concept (Time Period Assumption) – life of the entity is meaningfully
subdivided into equal time periods for reporting purposes; allows timely information for
decision making
 Stable Monetary Unit Concept - the Philippine peso is a reasonable unit of measure and
its purchasing power is relatively stable; basis for ignoring the effects of inflation
 Going Concern/Continuity Assumption – assumption that the entity will continue to
operate in the foreseeable future; this assumption underlies the depreciation of assets over
their useful life.
 Accrual Basis – depicts the effects of transactions and other events and circumstances on
a reporting entity’s economic resources and claims in the periods in which those effects
occur, even if the cash receipts and payments do not occur in the same period.
GENERALLY ACCEPTED ACCOUNTING PRINCIPLE (GAAP)
DEFINITION
Encompass the conventions, rules and procedures necessary to define accepted accounting
practice at a particular time.
CRITERIA (FOR):
a. Feasibility – can be implemented without undue complexity or cost
b. Objectivity – not influenced by personal bias or judgment; connotes reliability and verifiability
c. Relevance – resulting to information that is useful and meaningful to the users
BASIC PRINCIPLES (A CHROME)
• Adequate Disclosure – all relevant information affecting the user’s understanding and
assessment be disclosed in the financial statements (the means by which information
accumulated and processed in financial accounting is periodically communicated to the users)
• Consistency Principle – use of same accounting method from period to period to achieve
comparability over time within a single enterprise
• Historical Cost – acquired assets should be recorded at their actual cost
• Revenue Recognition Principle – revenue is to be recognized when goods are delivered or
services are performed or rendered.
• Objectivity Principle – accounting records and statements are based on reliable data; with
objective evidences
• Materiality – depends on the size and nature of an item judged in the particular circumstance of
its omission; is the financial information significant enough to affect an economic decision?
• Expense Recognition Principle – an entity record the expenses it incurred to generate the
revenue reported.
QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION
FUNDAMENTAL:
 Relevance
Capability of making a difference in the decisions made by users.
Financial information is capable of making a difference in decisions if it has predictive value,
confirmatory value, or both.
 Predictive value – can be used as an input to processes employed by users to predict future
outcomes.
 Confirmatory value – provides feedback about (confirms or changes) previous evaluations.
Materiality is also part of relevance.
Information is “material” if:
Omitting, misstating or obscuring it could reasonably be expected to influence decisions that the
primary users of general purpose financial statements make on the basis of those financial
statements
which provide financial information about a specific reporting entity.
Materiality is a practical boundary or constraint to achieving desired qualitative characteristics of
relevance on the type of information provided.
 Faithful Representation
Financial information must represent faithfully the phenomena it purports to represent (in words
and in
numbers). This means that numbers and descriptions match what really existed or happened.

COMPLETENESS NEUTRALITY FREEDOM FROM ERROR

PRUDENCE

ENHANCING
 Comparability
This enables users to identify and understand similarities in, and differences among, items.
Remember, comparability is not uniformity. For information to be comparable, like things must
look alike and different things must look different.
Comparability is the goal; consistency helps to achieve that goal.
Consistency refers to the use of the same methods for the same items, either from period to
period within a reporting entity or in a single period across entities.
 Verifiability
This helps assure users that information represents faithfully the economic it purports to
represent.
It means that different knowledgeable and independent observers could reach consensus,
although not necessarily complete agreement, that a particular depiction is a faithful
representation.
 Timeliness
This means that information is available to decision makers in time to be capable of influencing
their decisions.
  Understandability
This serves as a link between decision-makers and the accounting information.
“Classifying, characterizing and presenting information clearly and concisely” makes
information understandable.
Assumption:
Financial reports are prepared for users who have reasonable knowledge of business and
economic activities and who review and analyze the information with diligence.
TYPE OF BUSINESS
TYPE ACTIVITY STRUCTURE EXAMPLES
Service Selling people’s time Hiring skilled staff and Software development
selling their time Accounting
Legal
Trading Buying and selling Buying raw materials Wholesaler
products and manufactured Retailer
goods for
sale
Manufacturing Designing products, Taking raw materials Construction
aggregating and using equipment Food and Drink
components and and staff to convert Chemicals
assembling finished them into finished Media
products goods Pharmaceuticals
Raw Materials Growing or extracting Buying/leasing land Farming
raw materials and using them to Mining
provide raw materials Oil
Infrastructure Selling the utilization Buying and operating Transport
of assets; selling Hotels
infrastructure occupancy often in Telecoms
combination with
services
Financial Receiving deposits, Accepting cash from Bank
lending and investing depositors and paying Investment house
money them interest; using the
money to provide loans
to borrowers, charging
them fees a higher rate
of interest than the
depositors receive
Insurance Pooling premiums of Collecting cash from Insurance companies
many to meet claims of many customers;
a few investing the money to
pay the losses
experienced by a few
customers

Activities in Business Organizations

(1) OPERATING ACTIVITIES
Involve the use of resources to design, produce, distribute, and market goods and services.
Primarily principal revenue-producing activities of the organization.
Examples:
a) Sale of products and services
b) Payment of income tax
(2) FINANCING ACTIVITIES
Methods an organization uses to obtain financial resources from financial markets and how it
manages these resources.
Between the organization and the owners – equity financing
Between the entity and the creditors (e.g. suppliers, banks) – debt financing
Examples:
a) Borrowings/ loans
b) Issuance of shares
(3) INVESTING ACTIVITIES
Involve selection and management of long-term resources to be used to develop, produce, and
sell goods and services.
Generally acquisition and disposal of long-term resources and other investments.
Examples:
a) Acquisition of property
b) Disposal of equipment
FORMS OF BUSINESS ORGANIZATIONS
 Sole Proprietorship
Accounting viewpoint: Distinct from its proprietor
Legal viewpoint: One and the same with the proprietor
 Partnership
In a contract of partnership, two or more persons bind themselves to contribute money, property,
or industry to a common fund, with the intention of dividing the profit among themselves. (Civil
Code of the Philippines, Art. 1767)
Accounting viewpoint: Distinct from its partners
Legal viewpoint: One and the same with the partners
 Corporation
A corporation is an artificial being created by the operation of law, having the right of succession
and the powers, attributes and properties expressly authorized by law or incident to its existence.
(Revised Corporation Code of the Philippines, Sec. 2)
Accounting viewpoint: Distinct from its shareholders
Legal viewpoint: Distinct from its shareholders
Comparing the three forms of business organization:
FORM SOLE PARTNERSHIP CORPORATION
PROPRIETOR
Owner/s Single owner Two or more partners Stockholders (one or
(proprietor) more)
Profit/Loss Owner absorbs all Partners divide Profits are distributed
profits/losses based through dividends
on agreement
Liability/obligation to Owner solely Each partner is Stockholders are not
third person responsible personally liable personally liable
Equity Account Owner’s equity (e.g. Partners’ equity (e.g. Share capital
“Infante, Capital”) “Infante, Capital; Retained earnings
Lamata, Capital; and
Yusay, Capital”)
SOLE PROPRIETORSHIPS
Advantages:
 Easy to set-up and continue
 Requires a small amount of capital to start.
 Profits all accrue to the owner.
 Total control on the part of the owner.
Disadvantages:
 Unlimited personal liability.
 Limited management skills.
 Limited access to capital.
 Lacks continuity in case of death or incapacity of owner.

PARTNERSHIPS
Characteristics:
 Mutual Contribution
 Division of Profits or Losses
 Co-ownership of Contributed Assets
 Mutual Agency
 Limited Life
 Unlimited Liability
 Income Taxes
 Partners’ Equity Accounts
Advantages versus Proprietorships:
 Brings greater financial capability to the business.
 Combines special skills, expertise and experience of the partners.
 Offers relative freedom and flexibility of action in decision-making.
 Risks are shared.
Advantages versus Corporations:
 Easier and less expensive to organize.
 More personal and informal.
Disadvantages:
 Profits are shared.
 Easily dissolved and thus unstable compared to a corporation.
 Mutual agency and unlimited liability may create personal
obligations to partners.
 Less effective than a corporation in raising large amounts of capital.
CORPORATIONS
Advantages:
 The corporation has the legal capacity to act as a legal entity.
 Shareholders have limited liability.
 It has continuity of existence.
 Shares of stock can be transferred without consent of other
shareholders.
 Its management is centralized in the board of directors.
 Shareholders are not general agents of the business.
 Greater ability to acquire funds.
Disadvantages:
 A corporation is relatively complicated in formation and
management.
 There is a greater degree of government control and supervision.
 It requires a relatively high cost of formation and operation.
 It is subject to heavier taxation that other forms of business
organizations.
 Minority shareholders are subservient to the wishes of the majority.
 In large corporations, management and control have been separated
from ownership.
 Transferability of shares permits the uniting of incompatible and
conflicting elements in one venture.