University of Saint Louis Tuguegarao

Accounting 1013: Conceptual Framework and Accounting Standards

Handout No. 01: Definition of Accounting

Definition of Accounting

According to the American Association of Accountants (AAA), accounting is "the process of

identifying, measuring, and communicating economic information to permit informed judgments
and decisions by users of the information."

Three important activities included in the definition of accounting [Mnemonic - I Miss Childhood]:
1. Identifying - knowing “what”
2. Measuring - knowing “how much”
3. Communicating - knowing “how” and “to whom”

Identifying

Identifying is the process of analyzing events and transactions to determine whether or not
they will be recognized. The formal process of including the effects of an accountable event in
the statement of financial position or the statement of comprehensive income through a journal
entry is called “recognition.”

TAKE NOTE: Only accountable events are recognized (i.e., journalized).

An accountable event is one that affects the assets, liabilities, equity, income or expenses of
an entity. It is also known as economic activity, which is the subject matter of accounting.

Therefore, sociological and psychological matters are not recognized.

Non-accountable events are not recognized but disclosed only in the notes, if they have
accounting relevance. Disclosure only in the notes is not an application of the recognition
process. A non-accountable event that has an accounting relevance may be recorded through a
memorandum entry.

Summary of Recognition Rules:

If the event is… …and has… Then we should

Accountable Accounting relevance Recognize with JOURNAL ENTRY

Non-accountable Accounting relevance Make a MEMO ENTRY

 Non-accountable No accounting relevance Ignore
Types of events or transactions

External events - are events that involve an entity and another external party. External events
include
a. Exchange (reciprocal transfer) - an event wherein there is a reciprocal giving and
receiving of economic resources or discharging of economic obligations between
an entity and an external party. Examples: sale, purchase, payment of
liabilities, receipt of notes receivable in exchange for accounts receivable,
and the like.
b. Non-reciprocal transfer - is a "one way" transaction in that the party giving
something does not receive anything in return, while the party receiving does not
give anything in exchange. Examples: donations, gifts or charitable
contributions, payment of taxes, imposition of fines, theft, provision of
capital by owners, distributions to owners, and the like.
c. External event other than transfer - an event that involves changes in the economic
resources or obligations of an entity caused by an external party or external
source but does not involve transfers of resources or obligations. Examples:
changes in fair values and price levels, obsolescence, technological
changes, vandalism, and the like.

Internal events - are events that do not involve an external party. Internal events include

a. Production - the process by which resources are transformed into finished goods.
Examples: conversion of raw materials into finished products, production
of farm products, and the like.
b. Casualty - an unanticipated loss from disasters or other similar events. Examples:
loss from fire, flood, and other catastrophes.

Measuring

Measuring involves assigning numbers, normally in monetary terms, to the economic

transactions and events.

Several measurement bases are used in accounting which include, but not limited to, historical
cost, fair value, present value, realizable value, current cost, replacement cost and sometimes
inflation-adjusted costs.

Take note: The most commonly used is historical cost.

This is usually combined with the other measurement bases. Accordingly, financial statements
are said to be prepared using a mixture of costs and values. Costs include historical cost and
current cost while values include the other measurement bases.
Valuation by fact or opinion

The use of estimates is essential in providing relevant information. Thus, financial statements
are said to be a mixture of fact and opinion.

When measurement is affected by estimates, the items measured are said to be valued by
opinion. Examples would include
a. Estimates of uncollectible amounts of receivables.
b. Depreciation and amortization expenses, which are affected by estimates of useful life
and residual value.
c. Estimated liabilities, such as provisions.
d. Retained earnings, which is affected by various estimates of income and expenses

When measurement is unaffected by estimates, the items measured are said to be valued by
fact. Examples would include
a. Ordinary share capital valued at par value
b. Land stated at acquisition cost
c. Cash measured at face amount

Communicating

Communicating is the process of transforming economic data into useful accounting

information, such as financial statements and other accounting reports, for dissemination to
users. It also involves interpreting the significance of the processed information.

The communicating process of accounting involves three aspects:

1. Recording - refers to the process of systematically committing into writing the identified
and measured accountable events in the journal through journal entries.
2. Classifying - involves the grouping of similar and interrelated items into their respective
classes through postings in the ledger.
3. Summarizing - putting together or expressing in condensed form the recorded and
classified transactions and events. This includes the preparation of financial statements
and other accounting reports.

Interpreting the processed information involves the computation of financial statement ratios.
Some regulatory bodies, such as the Bangko Sentral ng Pilipinas (BSP), require certain financial
ratios to be disclosed in the notes to financial statements.