Introduction to Accounting PDF

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Introduction to Accounting...

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Introduction to Accounting I. Nature of Accounting Accounting as the Language of Business Accounting is the process of gathering financial information about a business and reporting this information to its end users. Accounting is also called the language of business. (Cabrera, 2016) The following are the three (3) widely-accepted definitions of accounting (Rabo, Tugas, & Salendrez, 2016): 

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According to American Accounting Association (AAA), accounting is the process of identifying, measuring, and communicating economic information to permit informed judgment and decisions by users of the information. American Institute of Certified Public Accountants (AICPA) defines accounting as 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 financial character, and interpreting the results thereof. The Accounting Standards Council (ASC) see accounting as a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities, intended to be useful in making economic decisions.

Function of Accounting An information system in itself, accounting performs the following tasks (Rabo, Tugas, & Salendrez, 2016):   

To fulfill the stewardship function of the management (or owners). To help interested users come up with informed decisions; and To support daily operations of the business.

History of Accounting The origin of accounting and its subsequent development are best studied the context of the history of commercial transactions. Accounting is a function of the business environment in which it operates and it responded to the changing nature of business transactions and the need to record them properly (Cabrera, 2016). The origins of accounting can be traced from the Renaissance period. Particularly, the Italian monk and mathematician Frater Luca Bartolomes Pacioli born during 1445 in Sansepolcro, Tuscany. He was a mathematician and friend of Leonardo

da Vinci. He wrote and taught in many fields including mathematics, theology, architecture, games, military strategy, and commerce. In 1494, Pacioli published his famous book ‘Summa de Arithmetica, Geometria, Proportioni et Proportionalita’ (The Collected Knowledge of Arithmetic, Geometry, Proportion and Proportionality). A section of this book was dedicated to the description of double-entry accounting (this will be discussed under ‘Recording Business Transactions’ topic).

II. Branches of Accounting The main areas of accounting are: 

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Financial Accounting – The gathering, classifying, analyzing, recording of financial data in the books of accounts, and preparation of reports to management on the financial data. Management Accounting – The gathering and reporting to management of data necessary for management decisions. Auditing  Internal Auditing – Reviews the business operations to check if they comply to management policies.  External Auditing – The work of Certified Public Accountants (CPA) outside the business organization, in ascertaining the correctness of data in the financial statements, for the statements’ acceptability to the public and to government regulatory agencies. Tax Accounting – Deals with the preparation of various tax returns and doing tax planning for the business. Government Accounting – Used by all branches of the government and by those who receive government funds to oversee the complicated business of providing government services or to report to the government on the use of government funding in compliance with the imposed regulations (Cabrera, 2016). Cost Accounting – Analyzes the costs incurred by the business to help managers control expenses. Good cost accounting records guide managers in pricing their products and services to achieve greater profits. Accounting Education – Responsible for training future accountants. It engages in teaching accounting, financial management, taxation, and other related business course. CPAs are encouraged to be part of the academe and become an integral force in inspiring students to pursue a career in accounting. Accounting Research - Plays an essential part in creating new knowledge. The hard sciences have produced models of research and testing that can be used and applied over many disciplines including accounting research.

III. Users of Accounting Information Internal Users – Those who make decisions that affect the internal operations of the company.  Managers – Those who plan, organize, and run the business.  Owners – They provide the capital to the business. Accounting information is needed by the owners to help them decide whether they should withdraw or increase investments, as well as, determine the return on their investment External Users – Those who make their decisions based on the company’s financial information.  Investors – Financial information will help them decide whether they should invest or not in the business.  Creditors – They asses credit worthiness and the capability of the business to pay its obligation including the related interests on maturity date.  Customers – They have interest in information about the continuance of an enterprise, especially when they have a long-term involvement with, or are dependent on, the enterprise.  Employees – Assess the company’s profitability and stability, its consequence on their future  salary and job security.  Suppliers – They use the financial information to determine whether the debts owed to them will be paid when due or whether the customer has enough funds or resources to pay the goods to be delivered or the services to be rendered.  Tax Authorities – Determines the credibility of the tax returns filed on behalf of the company. They are interested to know if the business paid the correct amount of taxes.  Government and Regulatory Bodies – Ensures that the company’s 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.  Public – They use the financial information to know the trends and recent developments in the prosperity of the enterprise and the range of its activities.

IV. Forms of Business Organizations 

Sole Proprietorship – This is the simplest form of business organization where only one (1) individual owns the business

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Partnership –Article 1767 of the New Civil Code of the Philippines defined partnership as ‘contracts whereby two (2) or more persons bind themselves to contribute money, property or industry to a common fund with the intention of dividing the profits among themselves’  General Partnership – Each partner has unlimited liability for the debts incurred by the business. Usually manage the firm and may enter into contractual obligations on the firm’s behalf.  Limited Partnership – Contains one (1) or more general partners and one (1) or more limited partners. The personal liability of a general partner for the firm’s debt is unlimited while the personal liability of limited partners is limited to their investment. Corporation – A separate body consisting of at least five (5) to 15 individuals treated by law as a unit. According to Section 2 of the Corporation Code of the Philippines, a corporation is ‘an artificial being created by operation of law, having the right of succession and the powers, attributes and properties expressly authorized by law or incident to its existence

V. Types of Business According to Activities 

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Service Business – Focuses on providing intangible products such as offering professional skills, proposals, and expertise. Examples are accounting firms, law firms, schools, medical clinics, banks, hair salons and spas, and repair shops. Merchandising Business – Commonly known as the “buy and sell” business. Products are bought from manufacturers or other merchandisers and are sold as is at an amount higher than the purchase price. Examples are grocery stores, hardware, department stores, and drug stores (Rabo, Tugas, & Salendrez, 2016). Manufacturing Business – The process of converting raw materials into finished products. The manufacturer buys the raw materials, applies direct labor and factory overhead to create finished products (Frias, 2016 ). Examples are food factories, garment factories, and car manufacturing companies.

VI. Accounting Concepts and Principles Generally Accepted Accounting Principles The accounting profession has developed standards that are generally accepted and universally practiced. This common set of standards is called Generally Accepted Accounting Principles (GAAP). These standards indicate how to report economic events. (Weygandt, Keiso, & Kimmel, 2012) This has been developed by the accounting professionals to guide preparers of financial statements in recording and reporting

financial information regarding a business enterprise, hence aiding in the effective execution of the accounting procedure and in communicating the financial condition of the business (Rabo, Tugas, & Salendrez, 2016).

Underlying Assumptions (Rabo, Tugas, & Salendrez, 2016) 1. Economic Entity – Assumes that all of the business transactions are separated from the owner’s personal transactions. 2. Accrual Basis – Requires that all business transactions and other events are recognized in the accounting records when they occur, rather than when the cash or equivalent is received or paid 3. Going Concern – This assumes that a company will continue to exist long enough to carry out its objectives and commitments and will not liquidate in the foreseeable future. 4. Monetary Unit – Assumes that only transactions that can be expressed in terms of money are recorded. 5. Time-Period – Requires a business to complete the whole accounting process of a business over a specific operating time period. It may be monthly, quarterly, semiannually, or annually.  Calendar Year – A 12-month period that ends on December 31.  Fiscal Year – A 12-month period that may or may not end on December 31.

Basic Accounting Principles (Rabo, Tugas, & Salendrez, 2016) 1. Cost Principle – Cost refers to the amount spent when an item was originally obtained, whether that purchase happened last year or 10 years ago; amounts are not adjusted upward for inflation 2. Full Disclosure Principle – In preparing financial statements, the accountant should include sufficient information to permit the stakeholders to make an informed judgement about the financial condition of the enterprise. 3. Matching Principle – Requires that expenses be matched with revenues. Meaning, in a given accounting period, the recorded revenue should have an equivalent expense recorded, in order to show the true profit of the business. 4. Revenue Recognition Principle – Revenues are recognized as soon as goods have been sold or a service has been rendered, regardless of when the money is actually received. 5. Materiality Principle – Business transactions that may affect the decision of a user of financial information are considered important or material, and thus, must be reported properly.

6. Conservatism Principle – States that given two (2) options in the valuation of business transactions, the amount recorded should be the lower value rather than the higher value 7. Objectivity Principle – Requires business transactions to have some form of impartial supporting evidence or documentation.

Qualitative Characteristics of Financial Statements (Rante, 2013) 1. Understandability – The information provided in the financial statements must be easily understood by the users. 2. Relevance – Information contained in the financial statements must be relevant to the needs of the users. 3. Materiality – Omission or misstatement of information must not influence the economic decision of users taken on the basis of the financial statements. 4. Reliability – Information must be free from material error and bias and be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. 5. Faithful Representation – For information to be reliable, it must represent the transactions faithfully and other events it purports to represent. 6. Substance Over Form – It is necessary that the information contained in the financial statements are accounted for and presented in accordance with their substance rather than in their legal form. 7. Prudence or Conservatism – Prudence is the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that assets or revenue are not overstated and liabilities or expenses are not understated. 8. Completeness – The information in the financial statements must be complete within the bounds materiality and cost. 9. Comparability – Users must be able to compare the financial statements of an enterprise in order to evaluate the economic trends in the industry and in order to evaluate the performance of different enterprise in the same industry. 10.Timeliness – Information may lose its relevance if not timely reported. Even if the information is very reliable if reporting is delayed, then that information will have little use or no use at all to the users who have to make interim decisions. 11. Neutrality – Information contained in the financial statement must be impartial, that is free from bias....