Accounting 2B

Introduction to
Accounting
Definition:
“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 Standard Council
 
“Accounting is an art of recording, classifying and 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
result thereof.”
 
- American Institute of Certified Public Accountants
History
History indicates that all developed societies require certain accounting
records. Record-keeping in an accounting sense is thought to have begun
about 4000 BCE.
 
The record-keeping, control, and verification problems of the ancient world
had manycharacteristics similar to those we encounter today. For example,
ancient governments also kept records of receipts and disbursements and
used procedures to check on the honesty and reliability of employees..
 
A study of the evolution of accounting suggests that accounting processes
have developed primarily
in response to business needs. Also, economic progress has affected the
development of accounting processes. History shows that the higher the
level of civilization, the more elaborate the accounting methods.
History
The emergence of double-entry bookkeeping was a crucial event in accounting history.
In 1494, a Franciscan monk, Luca Pacioli, described the double-entry Method of
Venice system in his text called Summa de Arithmetica, Geometric, Proportion et
Proportionate (Everything about arithmetic, geometry, and proportion). Many consider
Pacioli's Summa to be a reworked version of a manuscript that circulated among
teachers and pupils of the Venetian school of commerce and arithmetic.
 
Since Pacioli's days, the roles of accountants and professional accounting
organizations have expanded in business and society. As professionals, accountants
have a responsibility for placing public service above their commitment to personal
economic gain. Complementing their obligation to society, accountants have analytical
and evaluative skills needed in the solution of ever-growing world problems. The
special abilities of accountants, their independence, and their high ethical standards
permit them to make significant and unique contributions to business and areas of
public interest..
Purpose
The accounting system of a profit-seeking business is an
information system designed to provide relevant financial
information on the resources of a business and the effects of
their use. Information is relevant if it has some impact on a
decision that must be made.
 
Companies present this relevant information in their financial
statements. In preparing these statements, accountants
consider the users of the information, such as owners and
creditors, and decisions they make that require financial
information..
There are three main types of business entity:

1. Sole Proprietorship
2. Partnership
3. Corporation
Sole Proprietorship

A form of business organization in which

there is only one owner Examples may
include the local shopkeeper, a plumber
and a hairdresser.
 
Advantage of a proprietorship
1.  Easy to start. Anyone with a good idea and the willingness to
accept risks can start a business as a proprietorship.
2. Little government regulation. Accurate tax records must be
kept and certain employment guidelines must be followed. In
most cases, proprietorship has the least regulations.
3. Complete control. Owner has complete authority over business
decisions. The owner decides alone on what product to produce,
how many hours will the firm be open for service and who will be
the manager of the firm.
4. Lower taxes. The tax is the same as the personal income of the
proprietor.
Disadvantage of a proprietorship

1. Unlimited liability. The owner’s personal assets can

be used to pay bill of the business or it can also be
used to pay debts of the business.
2. Limited life of the business. If the owner dies, the
business ceases to exist.
3. Difficult to raise money. It is difficult and expensive
to raise money due to financial limitations of the
owner.
Partnership
Partnership is an agreement in which two or more
persons combine their resources in a business with a
view to make a profit. In order to establish the terms of
the business and to protect partners/shareholders in the
event of disagreement or dissolution of the business, a
partnership/shareholders agreement should be drawn up,
usually with the assistance of a lawyer. Partners share in
the profits according to the terms of the agreement.
 
Advantage of a partnership
1. Easy to start. Partners need only to agree on how they will share
both responsibilities and rewards.
2. Little government regulation. They only need to keep good
records for tax purposes and meet guidelines related to
employment practices
3. Not difficult to raise funds. All partners’ financial assets are
considered by a bank or other lender. This makes it possible for the
partners to have some money available to put into the business
directly.
4. Combination of skills. Using the distinct skills of each partner
may increase the efficiency of the firm. One partner may be good
at selling and the other better at record keeping.
Disadvantage of a partnership
1. Unlimited liability. The owner’s personal assets can be used to pay debts
of the firm. Even a partner who has not put any money into the business is
subject to unlimited liability.
2. Profits are shared. Profits must be shared according to their partnership
agreement. Even if you work hard or not, the share will depend on the
agreement.
3. Limited life of the business. Business stops when any one of the
partners dies or is unable to participate. Thus, a successful business may
have to be ended even though other partners may want to continue it.
4. Disagreements. They may have the same plan but they may differ in
carrying out these plans. Disagreements could lead to inefficient
operations and even to the end of partnership.
Corporation
 
A legal entity that is separate from its owners, the
shareholders. No shareholder of a corporation is
personally liable for the debts, obligations or acts of
the corporation. Directors, officers and insiders can
bear some liability for their involvement with the
corporation.
Advantage of a corporation
1. Easy to raise funds. More alternatives or methods of acquiring
funds.
2. Limited liability. It is the concept that owners of a business are only
responsible for its debts up to the amount they invest in the business.
Stockholders (owners) only risk the money they paid for the stock. If
the corporation goes bankrupt or is sued, the owner’s other assets
cannot be used to pay the debts of the business
3. Unlimited life. Even if all the owners of stock died, the corporation
will continue.
4. Risks are shared. Each stockholder takes some risk. However, it is
not necessary for the stockholders to accept all the risk.
Disadvantage of a corporation
1. Difficult to start. This requires government approval which could result
into bureaucracy. Bureaucracy refers to a business/government system
that is characterized by “red tape” and other complicated processes.
2. Less direct control. Professional managers run the business and are in
charge of the firm’s operations. Owners are usually far from the day‐ to‐
day operation of the business
3. Double taxation. The corporation’s profits are taxed by corporate
income taxes. The corporation also pays dividends which are out of the
firm’s after‐tax income. Dividends are parts of the corporation’s income
that is paid to its stockholders. Then, stockholders pay personal income
taxes on the dividends. Thus, each peso of the corporation earnings may
get taxed twice.
Types of activities performed by business organization

1. Service Business
2. Merchandising Business
3. Manufacturing Business
Service Business

Perform services for a fee. This group includes

accounting firms, law firms, and dry cleaning
establishments. The early chapters of this text
describe accounting for service companies..
Merchandising Business

Purchase goods that are ready for sale and

then sell them to customers. Merchandising
companies include auto dealerships, clothing
stores, and supermarkets.
Manufacturing Business

Buy materials, convert them into products, and then

sell the products to other companies or to the final
consumers. Manufacturing companies include steel
mills, auto manufacturers, and clothing
manufacturers..
Generally Accepted Accounting Principles
Generally Accepted Accounting Principles represent the rules,
procedures, practice and standards followed in the presentation
and preparation of financial statements.

1. In the Philippines, the development of GAAP is formalized

initially through the creation of Accounting Standard
Councils or ASC.
2. The approved statement of the ASC are called previously as
“Statement of Financial Accounting Standards or SFAS”
3. These Statement of Financial Accounting Standards are now
known as Philippine Accounting Standards or PAS and
Philippine Financial Reporting Standards or PFRS.
Purpose of Accounting Standards

The overall purpose of accounting

standards is to identify proper accounting
practices for the preparation and
presentation of financial statements.
Financial Reporting Standard Council

Financial Reporting Standard Council or FRSC now

replace the ASC. It is the accounting standard setting
body created by the Professional Regulation
Commission upon recommendation of the Board of
Accountancy to assist the Board of Accountancy in
carrying out its powers and function provided under R.A
No. 9298
 
Conceptual Framework For Financial Reporting

1. The Conceptual Framework for financial Reporting was

approved by the International Accounting Standards
Board(IASB) in September 2010.
2. The IFRS Framework addresses the following:
 The objectives of financial reporting
 The quantitative characteristics of useful financial information
 The reporting entity
 The definition , recognition and measurement of the element
from which FS are constructed
 Concepts of capital and capital maintenance
 Conceptual Framework For Financial Reporting

3. Cost Constraint. Financial reporting imposes costs; it is

important that the benefits of financial reporting should
justify those costs.
4. GOING CONCERN assumption. “Going Concern”
presumes that the entity will continue its operation
indefinitely or, if that presumption is not valid, disclosure
and a different basis of reporting are required. Accrual
basis is mentioned in the new framework in the section
on “objectives of financial reporting.
Purpose of Framework of Accounting
a) Assist the FRSC in developing accounting standards that will represent
Philippine GAAP
b) Assists [preparers of financial statements in applying accounting
standards and in dealing with issues not yet covered by GAAP
c) Assists the FRSC in its review and adoption of International Financial
Reporting Standards
d) Assist users if financial statements in interpreting the information
contained in the financial statements
e) Assist auditors in forming an opinion as to whether financial statements
conform with Philippine GAAP
f) Provided information to those interested in the work of the FRSC in the
formulation of PFRS.
Objective of Financial Reporting

'The objective of general purpose financial

reporting is to provide financial information
about the reporting entity that is useful to
existing and potential investors, lenders and
other creditors in making decisions about
providing resources to the entity.'.
Users of Financial Information

1. External Users
2. Internal Users
External Users
The external users of accounting information fall into six groups; each has different interests in the
company and wants answers to unique questions. The groups and some of their possible questions
are:
 
a. Owners and prospective owners. Has the company earned satisfactory income on its total
investment? Should an investment be made in this company? Should the present investment be
increased, decreased, or retained at the same level? Can the company install costly pollution
control equipment and still be profitable?
b. Creditors and lenders. Should a loan be granted to the company? Will the company be able to
pay its debts as they become due?
c. Employees and their unions. Does the company have the ability to pay increased wages? Is
the company financially able to provide long-term employment for its workforce?
d. Customers. Does the company offer useful products at fair prices? Will the company survive
long enough to honor its product warranties?
e. Governmental units. Is the company, such as a local public utility, charging a fair rate for its
services?
Internal Users
Internal Users includes the board of directors, chief executive officers, chief financial
officers, vice presidents, business unit managers, plant managers and the supervisors
 
Qualitative Characteristics of Useful Financial Information
1. Relevance(Fundamental Characteristic)
a. Confirmatory Value
b. Predictive Value
2. Faithful Representation(Fundamental Characteristics)
a. Freedom from error
b. Neutrality
c. Completeness
3. Comparability(Enhanced Characteristic)
4. Understandability( Enhanced Characteristic)
5. Timeliness(Enhanced Characteristic)
6. Verifiability(Enhanced Characteristic)
Fundamental Characteristic

1. Relevance
2. Faithful Representation
 Relevance
Relevant financial information is capable of making a difference in the
decisions made by users. Information on financial position and
performance is often used to predict future position and performance
and other things of interest to the user, e.g. likely dividend, wage rises.
Financial information is also used to confirm (or change) users' past
conclusions about an entity's financial performance or financial position.
 
Information can have both predictive value and confirmatory value. For
example, revenue for the current year can be used to predict revenue
for next year. Actual revenue for the current year can also be compared
with expected revenue that was predicted using last year's financial
statements.
 Faithful Representation
To be useful, financial information must faithfully represent the economic
events that it purports to represent. The user must be able to depend on it
being a faithful representation..
 
a. Completeness- A complete depiction includes all the information
necessary for a user to understand the phenomenon being depicted,
including all necessary descriptions and explanations.
b. Neutrality- A neutral depiction is without bias in the selection or
presentation of financial information. This means that information must not
be manipulated in any way in order to influence the decisions of users.
c. Freedom from error- means there are no errors or omissions in the
description of the phenomenon and no errors made in the process by
which the financial information was produced. It does not mean that no
inaccuracies can arise, particularly where estimates have to be made.
Enhanced Characteristics

1. Comparability
2. Understandability
3. Timeliness
4. Verifiability
Comparability

Comparability is the qualitative characteristic that

enables users to identify and understand similarities in,
and differences among, items. Information about a
reporting entity is more useful if it can be compared with
similar information about other entities and with similar
information about the same entity for another period or
another date.
 Understandability
Classifying, characterising and presenting information clearly and
concisely makes it understandable. Some information is inherently
complex and difficult to understand. Excluding this information from
the financial statements would make them more understandable,
but they would also be incomplete and potentially misleading.
 
Financial reports are prepared for users who have a reasonable
knowledge of business and economic activities and who review and
analyse the information diligently. Users may sometimes need to
seek help from an adviser in order to understand information about
complex economic events.
Timeliness

Timeliness means having information available to

users in time to be capable of influencing their
decisions. Generally, the older the information is,
the less useful it is. However, older financial
information may still be useful for identifying and
assessing trends (for example, growth in profits
over a number of years).
Verifiability

Verifiability helps assure users that information

faithfully represents the economic events it
purports to represent. Verifiability means that
different knowledgeable and independent
observers could reach consensus (not necessarily
complete agreement) that a particular depiction is
a faithful representation.
Other concepts

1. Entity Concepts- an accounting entity is an

organization or a section of an organization that
stands apart from other organizations and individuals
as a separate economic unit.
2. Materiality- Information is material if omitting it or
misstating it could influence decisions that users make
on the basis of financial information about a specific
reporting entity.