CHAPTER 1: OVERVIEW ON ACCOUNTING

Overview on Accounting
Business
A business is an organization engaged in the trade of goods, services or both to
consumers, generally to earn profit and increase the wealth of the owners. A business
may be classified according to nature of their business as a service company,
merchandising company or manufacturing company.

Types of Businesses according to legal forms

1. Sole Proprietorship - this form of business has only one owner called the proprietor.
Advantages Disadvantages
Sole control over the operations Assumption of unlimited personal liability
Relatively easy to establish as there are Does not have the benefit of a second
less requirements mandated by law as opinion in the decision making
compared to other forms of businesses
No sharing of profits No sharing of losses
Income from business is taxes in personal Difficulty raising investment plan
income
Able to discontinue operations at will Life of business is dependent on the
owner’s

2. Partnership - this form of business stems from an agreement between two or more
persons (known as partners) through the contract of co-partnership.
Advantages Disadvantages
Has the benefit of a second opinion in the Partners are prone to encounter
decision making disagreement in decision making
Relatively easy to establish as there are Partners assume unlimited personal
less requirements mandated by law liability
More investments capital is available Life of the business is limited
Partners only pay personal tax Changes in ownership requires dissolution
of the business
Partners share in the loss Partners share in profits

3. Corporation - an artificial being created by law.

Advantages
Stockholders have limited liability
Can raise the most investment capital
Life of the business is unlimited
Ownership is easily transferrable without
the need to dissolve the business and
without the consent of other stockholders
Disadvantages
Earnings from investments in corporations
are taxes twice - the corporate income tax
and final tax on dividend income
Difficult to establish as it is more expensive
to start up
Difficult to establish as it is closely
regulated by the government agencies
Accounting defines as:
- A set of concepts and techniques that are used to measure and report financial
information about an economic unit.
- commonly described as the language of business. Through the information it delivers, it
seeks to communicate a variety of ideas to different users of financial information.

Processes of Accounting:
1. Identifying - Not all transactions of the company can be accounted for. The company
must identify economic events relevant to the business. These events may include sale
of goods to customer, purchase of supply from a vendor, manufacturing of products and
many others.

2. Measuring - Once the company has identified economic events, it must measure
those events in order to provide a history of its financial activities. Measuring can be
described as quantifying an economic event into financial terms by using monetary unit.

3. Communicating - After measuring the economic events, the company then

communicates the collected information to the users of financial information. This is
done so through the use of financial statements.

Accounting vs Bookkeeping
Bookkeeping is mainly related to identifying, measuring and recording financial
transactions. Its objective is simply to keep a record of all financial transactions of the
business; therefor, the management cannot make a decision by solely relying on the
data provided by bookkeeping.

Accounting, on the other hand, is the process of summarizing, interpreting and

communicating financial transactions which were classified in the ledger account.
Generally, the management relies on information provided by accounting to make
decisions.

Sectors in Accounting Practice

A. Public Practice - this sector includes individual practitioners and accounting firms that
render independent professional accounting services to the public. These services
includes auditing, tax services, and management consulting services.
B. Commerce and Industry - are employed by private companies. They usually assist
management in planning and controlling a company’s operations.
C. Education - this sector employs CPA’s as professors, reviewer and researchers.
D. Government - these are CPA’s hired by government units such as BIR, COA,
Department of Finance, SEC, and DBM.
CHAPTER 2: CONCEPTS IN ACCOUNTING
 Generally Accepted Accounting Principles
Accounting, like any language, follows certain rules and principles. These rules
and principles are known as the Generally Accepted Accounting Principles (GAAP). GAAP
is the set of rules, principles, standards, convention and underlying assumptions that are
used when preparing the financial statements.

GAAP serves as a guide for individuals in the accounting profession. These same
individuals have agreed and accepted these principles based in their experience,
customs, practical usage and necessity.

 Financial Reporting Standards Council

The Board of Accountancy (BOA) is tasked to enforce the provision of the
Philippines Accountancy Act. Upon its recommendation, the Professional Regulations
Commission (PRC) created the Financial Reporting Standard Council (FRSC). The primary
task of the council is to improve and establish accounting standards that will be
generally accepted in the Philippines.

The council will be composed by one chairperson and 14 representatives, all of whom
are appointed by the BOA.

a) Board of Accountancy - 1
b) Securities and Exchange Commission (SEC) - 1
c) Bangko Sentral ng Pilipinas (BSP) - 1
d) Bureau of Internal Revenue (BIR) - 1
e) A major organization composed of preparers
and users of financial statements - 1
f) Commission on Audit (COA) - 1
g) Accredited National Professional Organization
of Certified Public Accountants (CPAs)
Public Practice - 2
Commerce and Industry - 2
Academe/Education - 2
Government - 2

 Philippine Financial Reporting Standards

The Philippine Financial Reporting Standards (PFRS)/Philippine Accounting
Standards (PAS) are the new set of Generally Accepted Accounting Principles (GAAP)
issued by the Accounting Standards Council (ASC) to govern the preparation of financial
statements.

 Conceptual Framework
The Conceptual Framework is a body of interrelated objectives and
fundamentals. The objectives identify the goals and purposes of financial reporting and
the fundamentals are the underlying concepts that help achieve those objectives. Those
concepts provide guidance in selecting transactions, events and circumstances to be
accounted for, how they should be recognized and measured, and how they should be
summarized and reported.

Objectives of Financial Reporting

The objective of financial reporting is to provide financial information that is useful to
users in making decisions relating to providing resources to the entity.

The financial information is used by users to assess the management stewardship of the
company’s economics resources and prospects for future net cash inflows to the
company.

Qualitative Characteristics of Useful Information

For the information to be useful, it must be both relevant and must provide a faithful
representation of what it purports to represent.

The two fundamental qualitative characteristics of financial reports are relevance and
faithful representation.

The four enhancing qualitative characteristics are comparability, verifiability, timeliness

and understandability.

A. Fundamental qualitative characteristics:

1. Relevance
The characteristic of relevance implies that the information should have
predictive and confirmatory value for users in making and evaluating economic decisions.
The relevance of information is affected by its nature and materiality. Information is
material if omitting it or misstating it could influence decision making. A financial report
should include all information which is material to a particular entity.

2. Faithful representation
The characteristic of faithful representation implies that financial information
faithfully represents the phenomena it purports to represent. This depiction implies that
the financial information is complete, neutral and free from error.

B. Enhancing qualitative characteristics:

1. Comparability
The characteristic of comparability implies that users of financial statements
must be able to compare aspects of an entity at one time and over time, and between
entities at one time and over time. Therefore, the measurement and display of
transactions and events should be carried out in a consistent manner throughout an
entity, or fully explained if they are measured or displayed differently.

2. Verifiability
The characteristic of verifiability provides assurance that the information
faithfully represents what it purports to be representing.
3. Timeliness
The characteristic of timeliness means that the accounting information is
available to all stakeholders in time for decision-making purposes.

4. Understandability
The characteristic of understandability implies that preparers of information
have classified, characterized and presented the information clearly and concisely. The
financial reports are prepared with the assumption that its users have a ‘reasonable
knowledge’ of the business and its economic activities.

C. Cost Constraint
The users must assess the benefit of providing the information needs to justify
the cost providing the information needs to justify the cost of providing the information.
Users of Financial Statements
A. Internal Users
Internal Users are people within a business organization who use financial information.
Examples of internal users are owners, managers, and employees.

Some of the ways internal users employ accounting information include the following:
1. Assessing how management has discharged its responsibility for protecting and
managing the company’s resources.
2. Shaping decisions about when to borrow or invest company resources.
3. Shaping decisions about expansion or downsizing.

B. External Users
External users are people outside the business entity (organization) who use accounting
information. Examples of external users are suppliers, banks, customers, potential
investors, and government.

Some of the ways external users employ accounting information include the following:
1.Government require tax returns and other documents often prepared by accountants.
2. Banks or lending institutions may use accounting information to guide decisions such
as whether to lend or how much to lend a business.
3.Investors will also use accounting information to guide investment decisions.

Basic Accounting Principles

The preparation of the financial statements is governed by a set of accounting rules and
principles, often referred to as GAAP. These principles include:

1. Economic Entity Accounting Principle - states that the business is considered distinct
and separate from the owners of the business. Meaning, the personal transactions of
the owners should not be reflected in the financial statements of the business.

The only transactions of the owner which will be recorded by the company are the
transactions between the owner and the company, as in the case of investing in the
company and withdrawals from the company.

2. Monetary Unit Assumption Principle - dictates all activity be recorded to the same
currency. This principle is one of the examples of the enhancing qualitative characteristic
of comparability, since it will be difficult to compare items which are measured in
different currencies.

3. Specific Time Period Assumption - states that all financial statements have to indicate
the time period of the activity reported in order for them to be meaningful to those
reviewing them.

4. Full Disclosure Principle - states that a business is required to disclose all information
that relates to the function of its financial statements in notes accompanying the
statements. This principle follows the fundamental qualitative characteristic of faithful
representation in that disclosure must be complete.
5. Going Concern Principle - sometimes referred to as the “non-death principle”, this
principle assumes the business will continue to exist and function with no definite end
date.

6. Matching Principle - accounting for revenue and expenses are matched. Meaning, the
revenue and the expenses directly related to those revenues are reported in the same
accounting period. An example of this is the sale of a merchandise. The cost of the
merchandise will be recognized as expense when it is sold to customers and sales
revenue is earned.

7. Accrual basis - revenue is generally recognized using this principle of accounting.

Under the accrual basis of accounting, revenue is reported when it’s earned, regardless
of when payment for the product or service is actually received.

8. Materiality - is an entity-specific aspect of relevance based on the nature or

magnitude, or both, of the items to which the information related in the context of an
individual entity’s financial report, and that there is no uniform quantitative threshold
for materiality or predetermined material in a particular situation.

9. Conservatism - when there is more than one acceptable way to record a transaction,
this principle instructs the accountant to choose the option that’s best for the business
they’re working with. Most often, this principles is referred to as prudence.

FINANCIAL STATEMENTS AND REPORTING ENTITY

Reporting Entity - is an entity that is required to prepare financial statements. It is not
necessarily a juridical entity (legal entity), it might be a portion of an entity (segments
and branches) or comprise of more than one entity (joint operation on a joint
arrangement).

Components of Financial Statements

Financial Statements are a structured representation of the financial position and
financial performance of the entity. The objectives of the financial statements is to
provide information about the financial position, performance and cash flows of an
entity that is useful to a wide range of users in making economic decisions.

1. Financial Position - can be defined as the status of financial well-being of a company

as of a given date. It is explained as the liquidity and solvency of the company, which is
affected by the economic resources which it controls.

Solvency refers to a company’s capacity to meet its long-term financial commitments,

while Liquidity refers to an enterprise’s ability to pay short-term obligations.
Sample:

2. Financial Performance - can be defined as the ability of a company to generate profit

or incur a loss during a particular date range or accounting period. Financial
Performance can also be referred to as profitability. This type of information is
presented in the statement of comprehensive income.

Sample:
3. Statement of Changes in Capital - It shows the changes in the owner’s or stockholder’s
equity through the accounting period which is effected primarily of additional
investments, net income (loss) and withdrawals of owners.

Sample:

4. Statement of Cash Flows - it shows information of how changes in statement of

financial position and operation affect cash and cash equivalents. It is classified into
three activities such as Operating, Investing and Financing activities of the company. It is
concerned about the inflows and outflows of cash in the entity.
Sample:
5. Notes to Financial Statements - it provides additional information that is significant in
decision making which are not presented in the face of entity’s financial statements. It is
also known as footnotes. It is required by the full disclosure principle.

Sample:

Elements of the Financial Statements

(a) Assets, Liabilities and Equity, which relate to a reporting entity’s financial position;
and
(b) Income and Expenses, which relate to a reporting entity’s financial performance.

Since assets, liabilities and equity relates to financial position, which are reported as of
specific date, these are also known as permanent accounts.
Meanwhile, income and expense are pertain to financial performance, which are
reported for a particular accounting period only, which is why they can be referred to as
temporary accounts. Temporary accounts are closed every yearend to the permanents
accounts.

Assets
An asset is a present economic resource controlled by the entity as a result of past
events.

An economic resource is a right that has the potential to produce economic benefits. For
the potential to exist, it does not need to be certain, or even likely, that the right will
produce economic benefits. It is only necessary that the right already exists and that, in
at least one circumstance, it would produce for the entity economic benefits beyond
those available to all other parties. An economic resource could produce economic
benefits for an entity by entitling or enabling it to:
(a) Receive contractual cash flows or another economic resource;
(b) Exchange economic resources with another party on favorable terms;
(c) Produce cash inflows or avoid cash outflows by, for example:
(i) Using the economic resources either individually or in combination with other
economic resources to produce goods or provide services;
(ii) Using the economic resources to enhance the value of other economic
resources; or
(iii) Leasing the economic resources to another party;
(d) Receive cash or other economic resources by selling the economic resource; or
(e) Extinguish liabilities by transferring the economic resource.
Assets can be further classified into two - current assets and non-currents assets.

Current Assets are those reasonably expected to be realized to cash within one year
from the report date or the normal operating cycle of the business, whichever is longer.
Some examples are:

 Cash and Cash Equivalents

Cash includes cash on hand (petty cash funs) and cash in bank (savings and checking
account). Cash equivalents are highly liquid, short-term investments which are acquired
near its maturity date (usually within 3 month, but may differ based on company policy).

 Accounts Receivables
Open accounts which represent money owed by customers and are collectible in the
near future by the business. This usually arises from conducting the ordinary course of
business, I.e. rendering services or selling goods to customers.

 Notes Receivables
Represents a promise by the customer or other debtor to pay a fixed amount of money
evidenced by a written promissory note, and thus offers more security over accounts
receivables. A portion of notes receivable can be classified as a non-current asset if it is
expected to be collected beyond 12 months from the report date.

 Inventories
Refers to assets which are either held for sale in the ordinary course of business, in the
process of production for sale, or in the form of materials/supplies to be consumed in
the production process in the rendering of services.

 Prepaid Expenses
These are expenses not yet incurred but already paid by the company. Common
examples prepaid rent, supplies on hand and prepaid insurance. These assets will
eventually be converted into expenses when incurred.

Non-current Assets are assets which are not classified as current asset. Some examples
are:

 Property, Plant and Equipment

These are tangible assets held by the business for use in the production process or for
administrative purposes, and are expected to be used for more than one accounting
period. Examples are machinery, equipment, furnitures and fixtures, building and land.

 Intangible Assets
These are identifiable, non-monetary asset which lack physical substance. Examples are
franchise license, patent, copyrights and trademarks.
Liabilities
A liability is a present obligation of the entity to transfer an economic resource as a
result of past events. For a liability to exist, three criteria must all be satisfied:
(a) The entity has an obligation;
(b) The obligation is to transfer an economic source;
(c) The obligation is a present obligation that exists as a result of past events

An obligation is a duty or responsibility that an entity has no practical ability to avoid. An

obligation is always owned to another party.

Liabilities can also be classified into current liabilities and non-current liabilities.

Current Liabilities are those reasonable expected to be settled within one year from the
report date or the normal operating cycle of the business, whichever is longer. Some
examples are:

 Accounts Payable
Open accounts which represent money owed by the business and are payable in the
near future to the vendor/supplier.

 Notes Payable
Represents a promise by the business to pay a fixed amount of money to the vendor or
other creditor, evidenced by a written promissory note. A portion of notes payable can
be classified as a non-current liabilities if it is expected to be collected beyond 12
months from the report date.

 Unearned Revenue
Represents cash collected by the business for goods or services which are not yet
delivered or performed for the customer.

 Accrued Expenses
Represents amounts owed to other parties for expenses already incurred but are yet to
be paid. Examples are: salaries payable, interest payable, and taxes payable.

Non-current Liabilities are liabilities which are not classified as current liabilities. Some
examples are:

 Bonds Payable
Bonds are contracts between the issuer (the borrower) and the lender specifying the
terms of repayment which may include the maturity date, number of tranches to be paid,
interest rates to be paid and timing of interest payments. A portion of bonds payable
can be classified as a current liabilities if it is expected to be settled within 12 months
from the report date.

 Mortgage Payable
These are long term debts with a pledged asset acting as a security or collateral for the
debt, to protect the creditor in the event of default by the business. A portion of
mortgage payable can be classified as a current liabilities if it is expected to be settled
within 12 months from the report date.
Equity
Equity claims are claims on the residual interest in the assets of the entity after
deducting all its liabilities. In other words, they are claims against the entity that do not
meet the definition of a liability. In other words, liabilities are the claims of creditors in
the assets of the entity while equities are the claims of the owners of the entity in the
assets of the entity. Sometimes, equity is also referred to as capital or net assets.
Some examples are:

 Capital
Consists of investments made by the owner

 Drawings
Also known as withdrawals, these are the opposite of capital. This is when the company
distributes its assets to the owner.

 Income Summary
A temporary account that summarizes the revenues and expenses of the company on a
given period and may result to a debit or credit balance, depending on whether the
company resulted to a net loss or net gain, respectively.

Income
Income are increases in assets or decreases in liabilities, that results in increases in
equity, other than those relating to contributions from holders of equity claims.
Common Examples are:

 Service Revenue
Refers to earnings of a business from rendering services to its clients (in case of service
company)

 Sales Revenue
Refers to earnings of a business from selling merchandise to its customers (in case of
merchandising or manufacturing company)

 Interest Revenue
Refers to earnings from the passage of time with money committed in a certain find e.g.
bank deposits.

Expenses
Expenses are decreases in assets or increases in liabilities, which result in decreases in
equity, other than those relating to distributions to holders of equity claims.
Common examples are:

 Cost of Sales
Direct costs attributable to the merchandise sold to the customer (for merchandising
and manufacturing companies, or any business expense directly attributable to the
rendering of service to the client (for service companies).

 Salaries and wages expense

Compensation paid to employees of the business
 Utilities Expense
Includes cost of electricity, water, telecommunication and networking.

 Taxes and Licenses
Represent costs incurred to register the business and acquire rights to operate, as well
as taxes incurred.

 Doubtful Account Expense

Represents amounts from open accounts receivables which are estimated to be
uncollectible, and thus recognized as expense.

 Depreciation Expense
Represents the allocated portion of property, plant and equipment charged to expense
due to passage of time and/or regular wear and tear for a given accounting period.
References:
 De Jesus et al. A Closer look on Fundamentals of Accounting
 Birt J., et al. (2020). Accounting: Business Reporting for Decision Making 7th John Wiley & Sons
Australia, Ltd.