ISU MODULE TEMPLATE

Subject: FINANCIAL ACCOUNTING AND REPORTING

1. Title of the Module

Chapter 1: Introduction to Accounting

2. Introduction
This course demonstrates an understanding of the definition, nature,
function and history of accounting.

3. Learning Outcome
At the end of the chapter, the students should be able to:

 Explain the definition, purpose and scope of accounting.

 Enumerate and define the different branches of accounting.
 Understanding and appreciate the possible career opportunities.
 Identify users of financial information and their specific needs.
 Identify different business organization and their structure.
 Understanding the different classifications of business organizations and
their respective operations.
 Explain the fundamental accounting assumptions and principles as the
foundation of the practice of accounting profession.

Definition, purpose and scope of accounting.

INTRODUCTION

Many people think of accounting as a highly technical field which is practiced only by
professional accountants. Actually, almost all if not all, we practice accounting in one
way or another in an almost daily basis. Accounting is simply the means by which we
measure and describe the results of business activities, whether you are managing a
business, making investments, preparing your household budget, preparing your
income tax returns, or just paying your electric bills – you are working with accounting
concepts and accounting information.

Accounting is often called the language of business because it is widely used in

describing all types of business activities. Every investor, manager, and business
decision maker needs a clear understanding of accounting terms and concepts if he is
to participate and communicate effectively in the business community.
NATURE OF ACCOUNTING

What is accounting? The dictionary (Webster) defines accounting as the system of

recording and summarizing business and financial transactions and analyzing, verifying,
and reporting the results.

The committee on Terminology of the American Institute of Accountants defines

accounting as an art of recording, classifying, summarizing, in a significant manner and
in terms of money, transactions and events which are part, at least, of a financial
character and interpreting the results thereof.

The above definition mentions four different function.

1. Recording – means the setting down in writing accountable transactions and

events on the books or records of the business. Such as usually done on a
systematic and chronological order. Systematic recording means the adherence
to specific guidelines, rules, and principles while chronological recording means
the sequential recording of transactions or events by their dates of occurrence.

2. Classifying - means categorizing similar items into the same group or same
name based on certain characteristics or bases for better management of
business. Classification maybe based on liquidity, permanent nature or other
distinction.

3. Summarizing – means aggregating and creating a condensed version of the

recorded and classified information covering all relevant points for periodic
reporting of the business status. This is usually done annually, semi-annually,
quarterly, monthly, or as required by the users of information.

4. Interpreting – means the explanation, in understandable terms, of the data

recorded, classified, and summarized. This involves the provision of assistance
by the accountant through preparation of reports and explanations to aid
understanding considering that accounting is highly technical and specialized
field.

The accounting profession has its own definition of accounting as follows: “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.”

Quantitative refers for number, that is, the measurement of quantity or amount.

Actually, accounting is an information system that measures business activities, process

the information into reports, and communicates the reports to the users or decision
makers.
DIFFERENT BRANCHES OF ACCOUNTING

Management/Managerial Accounting
Management accounting emphasizes the preparation and analysis of accounting
information within the organization. The objective of managerial accounting is to provide
timely and relevant information for those internal users of accounting information, such
as the managers and employees in their decision-making needs. Oftentimes, these are
sensitive information and is not distributed to those outside the business - for example,
prices, plans to open up branches, customer list, etc.

Managerial accounting involves financial analysis, budgeting and forecasting, cost

analysis, evaluation of business decisions, and similar areas.

Government Accounting
Government accounting is the process of recording, analyzing, classifying,
summarizing, communicating, and interpreting financial information about the
government in aggregate and in detail reflecting transactions and other economic
events involving the receipt, spending, transfer, usability and disposition of assets and
liabilities.

This branch of accounting deals with how the funds of the government are recorded and
reported.

Auditing
There are two types of auditing: external and internal auditing.
External auditing refers to the examination of financial statements by an independent
CPA (Certified Public Accountant) with the purpose of expressing an opinion as to
fairness of presentation and compliance with the generally accepted accounting
principles (GAAP).

Internal auditing deals with determining the operational efficiency of the company
regarding the protection of the company’s assets, accuracy and reliability of the
accounting data, and adherence to certain management policies. It focuses on
evaluating the adequacy of a company's internal control structure by testing segregation
of duties, policies and procedures, degrees of authorization, and other controls
implemented by management.

Tax Accounting
Tax accounting helps clients follow rules set by tax authorities. It includes tax planning
and preparation of tax returns. It also involves determination of income tax and other
taxes, tax advisory services such as ways to minimize taxes legally, evaluation of the
consequences of tax decisions, and other tax-related matters.
Cost Accounting
Sometimes considered as a subset of management accounting, cost accounting
refers to the recording, presentation, and analysis of manufacturing costs. Cost
accounting is very useful in manufacturing businesses since they have the most
complicated costing process. Cost accountants also analyze actual and standard
costs to help managers determine future courses of action regarding the company's
operations.
Cost accounting will also help the owner set the selling price of his products. For
example, if the cost accounting records shows that the total cost to produce one bottle
of soda is PHP10, then the owner can set the selling price at PHP15.

Accounting Education
This branch of accounting deals with developing future accountants by creating relevant
accounting curriculum. Accounting professionals can become faculty members of
educational institutions. Accounting educators contribute to the development of the
profession through their effective teaching, publications of their research and influencing
students to pursue careers in accounting. Accounting teachers share their knowledge
on accounting so that students are informed of the importance of accounting and its use
in our daily lives.

Accounting Research
Accounting research focuses on the search for new knowledge on the effects of
economic events on the process of summarizing, analyzing, verifying, and reporting
standardized financial information, and on the effects of reported information on
economic events. Researchers typically choose a subject area and a methodology on
which to focus their efforts. The subject matter of accounting research may include
information systems, auditing and assurance, corporate governance, financials,
managerial, and tax. Accounting research plays an essential part in creating new
knowledge.
Academic accounting research "addresses all aspects of the accounting profession"
using a scientific method. Practicing accountants also conduct accounting research that
focuses on solving problems for a client or group of clients.
The Accounting research helps standard-setting bodies around the world to develop
new standards that will address recent issues or trend in global business.

Certified Public Accountant practice their profession in four main areas namely:

1. Practice in Public Accountancy

2. Practice in Commerce and Industry
 3. Practice in Academe
4. Practice in Government

Users of Accounting Information

The ultimate objective of accounting is to provide quantitative information and report

these through the financial statements to the users of this information

Users of financial information may be broadly categorized into internal or primary users
and external or secondary users.

Internal users
1. Management – is responsible for ensuring that a company meets its goals. The
management of an enterprise has the primary responsibility for the preparation
and presentation of the financial statements of the enterprises.

Management needs financial information for analyzing the organization’s

performance and position and taking appropriate measures to improve the
company results.

2. Employees – need financial information for assessing company’s profitability and

its consequence on their future remuneration and job security

3. Owners - need financial information for analyzing the viability and profitability of
their investments and determining any future course of action.

Accounting information is presented to internal users usually in the form of

management accounts, budgets, forecasts, and financial statements.

External users
1. Creditors – are interested in financial information for determining the credit
worthiness of the organization. Terms of credit are set by creditors according to
the assessment of their customers’ financial health. Creditors include suppliers
as well as lenders of finance such as banks.

2. Investors - the providers of risk capital and their advisers are concerned with risk
inherent in and return provided by their investments. They need information to
help them determine whether they should buy, hold, or sell. Shareholders are
 interested in information which enables them to assess the ability of the
enterprises to pay dividends.

3. Customers – have an interest on the information about the continuance of an

enterprise especially when they have long-term involvement with or are
dependent on the enterprise

4. Government and other regulatory authorities – for determining the

creditability of the tax returns filed on behalf of the company and for ensuring that
the disclosure of accounting information is in accordance with the rules and
regulations set in order to protect the interest of the stakeholders who rely on
such information in forming their decisions.

5. Public – enterprises affect members of the public in a variety of ways. For

example, enterprises may make a substantial contribution to the local economy
in many ways including the number of people they employ and their patronage of
local suppliers. Financial statements may assist the public by providing
information about trends and recent developments in the prosperity of the
enterprise and the range of its activities.

While some of the information needs of these users cannot be met by financial
statements, there are needs which are common to all users. As investors are
providers of risk capital to the enterprise, the provision of financial statements
that meet their needs will also meet most of the need of other users.

FORMS OF BUSINESS ORGANIZATIONS

Sole or Single Proprietorship

A sole or single proprietorship is a form of business organization owned by only one
individual. The individual referred to as a sole or proprietor.

Generally, the owner acts as the active manager, he may supply the capital from his
personal funds or borrow from other parties.

Partnership
Article 1767 of the New Civil Code of the Philippines defines partnership as “an
association of two or more persons who bind themselves to contribute money, property
or industry to a common fund, with the intention of dividing the profits among
themselves” Two or more persons may also form a partnership for the exercise of a
profession.
A partnership is a legal relationship among contracting parties. This relation originates
from a voluntary contract between them. The partnership contract may be oral or in
writing, or simply implied from the acts of the parties, as long as the element of the
mutual contribution and intent to divide the profits are present

Corporation
The Corporation Code of the Philippines defines corporation as “an artificial being
created by operation of law, having the rights of succession, and the powers, attributes
and properties expressly authorized by law or incident to its existence”.

Five or more persons are required to organize a corporation. The ownership is divided
into shares of stock. The owners of the corporation are called stockholders or
shareholders.

Each of the business form defined above has its own advantages and disadvantages.

Sole Proprietorship Partnership Corporation

Advantages Owners received all Can raise more Owners have

profits (and sustain funds than a sole limited liability
all loses) proprietorship which guarantees
that they cannot
lose more than
what they invested.
Low organizational Borrowing power can achieved large
costs enhanced by more size via sale of
owners ownership (stocks)
Income included More managerial Ownership (stocks)
and taxed on the skill is readily
proprietor’s transferrable
personal tax return
Independence Income included Long life of the firm
and taxed on
partner’s personal
tax return
Ease of dissolution Has better access
to financing
Disadvantages Owner has Owners have Taxes generally
 unlimited liability unlimited liability higher because
Total wealth can be and may have to corporate income is
taken to satisfy cover debts of the taxed
debts other partners
Limited fund-raising Limited life of the More expensive to
power tends to business organize than other
inhibit growth forms of business
Difficult to give Difficult to liquidate Subject to greater
employee long-run or transfer government
career partnership regulation
opportunities
Limited to the Lacks secrecy
management skills because
of the proprietor stockholders are
given reports

CLASSIFICATION OF BUSINESS ENTEPRISES

Service
Service enterprises are those engage in rendering services like repair shops, security
agencies, janitorial agencies, laundry shops, beauty parlors, dental clinics, massage
parlors, accounting firms, etc.

Merchandising or Trading
Merchandising or trading firms are those companies engage in purchasing goods that
are ready to be sold and resell these goods to customers without altering or changing
the products. Examples of these are supermarkets, department stores and the like.

Manufacturing
Manufacturing firms are engage in the manufacture of finished products. These
businesses buy raw materials and transform them into finished product. Examples of
these are garment factories, furniture factories, hallow-block manufacturers, etc.

CONCEPTUAL FRAMEWORK AND UNDELYING ASSUMPTIONS

The conceptual framework is a summary of the terms and concepts that underlie in the
preparation and presentation of financial statements for external users. It is an attempt
to provide an overall theoretical foundation for accounting which will guide standard-
setters, preparers, and users of financial information in the preparation and presentation
of financial statements.
Accounting assumptions are the basic notions or fundamental premises on which the
accounting process in based. These served as the foundation of accounting in order to
avoid misunderstanding.

There are five basic accounting assumptions, namely accounting entity, going
concern, time-period, accrual, and monetary unit.

Accounting Entity Concept

In accounting, the accounting entity is the specific business enterprise which may be
sole proprietorship, a partnership or a corporation. Under this assumption, the business
enterprise is treated as a unit separate and distinct from the owner or owners.

Thus, the personal transactions of the owners not affecting the business are not
recorded in the books of the business. The reason for this concept is to have a fair
presentation of financial statements. This is accomplished by a separate accounting of
business transaction from personal transaction of the owners.

Going Concern
Under this assumption, the business entity will continue to operate indefinitely in the
future unless there is evidence to the contrary.

Long-lived assets are recorded at cost and not expensed outright due to the assumption
that this will still be used in the future.

Time Period
Users of financial information need to make economic decisions at many points during
the life of a business enterprise. Because of this, it becomes necessary to prepare
periodic financial reports.

The time-period assumption requires that the indefinite life (under the going concern
assumption) of the business be divided into time-periods. The time periods maybe
monthly, quarterly, semi-annually or annually.

Accrual
In order to meet the objectives of proper reporting, financial statements should be
prepared on accrual basis of accounting. Accrual accounting means that income is
recognized when earned regardless of when received; expense is recognized when
incurred regardless of when payment is made.
The accrual basis of accounting is the main reason why adjustments have to be
prepared at the end of every accounting period. Under this basis, the effects of
transactions and other events are recognized when they occur (and not as cash or its
equivalent is received or paid) and they are recorded in the accounting records and
reported in the financial statements in the period to which they are relate.

Monetary Unit
Under the monetary unit assumption, only transactions and events that can be
quantified in terms of money are to be recorded in the accounting records.

Transactions that cannot be quantified are ignored for recording purposes.

References:
Financial Accounting and Reporting Part 1 (Fundamentals of Accounting)
Florencio Z. Reyno Jr. CPA, MBA / David Wagner M. Reyno, CPA, DBA

Financial Accounting and Reporting (Fundamentals)

Zeus Vernon B. Millan