Accounting, defined.

Accounting is the process of identifying, measuring and communicating economic

information to permit informed judgment and decision by users of the information.
(American Accounting Association)
Accounting is 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 a financial
character and interpreting the results thereof. (Committee on Accounting Terminology of
the American Institute of Certified Public Accountants; AICPA)
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.

SYSTEMATIC PROCESS

1. Identifying.[analytical component] The recognition or non-recognition of business

activities as “accountable” events.

a. Accountable: Borrowing of money from a bank; Sales of shares of stocks to new

shareholders/owners of business; purchase of land and building. The subject
matter of accounting is ECONOMIC activity or the measurement of economic
resources and economic obligations. ECONOMIC ACTIVITIES:

i. External transactions: borrowing money, purchase of merchandise, payment of

salaries to employees.
ii. Internal transactions: Production (manufacturing goods) and casualty loss.

b. Non-accountable: Hiring of new employees; retirement or death of company

president; entering into a contract of sale.

2. Measuring.[technical component] Assigning of peso amounts to the

ACCOUNTABLE transactions and events. Financial statements must be express in terms
of a common financial denominator. FINANCIAL statements without monetary amounts
would be largely unintelligible or incomprehensible. The Philippine peso is the unit of
measuring accountable economic transactions. Measurement bases:

a. Historical cost. The original monetary value of an economic item. [1] Historical
cost is based on the stable measuring unit assumption. In some circumstances,
assets and liabilities may be shown at their historical cost, as if there had been no
change in value since the date of acquisition. The balance sheet value of the item
may therefore differ from the "true" value.
b. Current cost. Price of replacing an asset identical to an existing one. It should be
of the same condition and age as well as have the same service potential. This is
relevant because the replacement cost will most likely be different than fair
market value or net realizable value.
 c. Net realizable value. The estimated selling price in the ordinary course of
business minus any cost to complete and to sell the goods. NRV is one of the
amounts considered when determining the lower of cost or market for items in
inventory.
d. Present Value. The value on a given date of a future payment or series of future
payments, discounted to reflect the time value of money and other factors such as
investment risk. Present value calculations are widely used in business and
economics to provide a means to compare cash flows at different times on a
meaningful "like to like" basis.

3. Communicating. [formal component] The process of preparing and distributing

accounting reports to potential users of accounting information. Implicit in the
communicating process are the recording, classifying and summarizing aspects of
accounting. {2nd definition of accounting}

a. Recording or journalizing is the process of systematically maintaining a record of

all economic business transactions after they have been identified and measured.
Book of Original entry.
b. Classifying is the sorting or grouping of similar and interrelated economic
transactions into their respective classes. Classifying is accomplished by posting
to the ledger. Posting is transferring of SAME information to their respective
LEDGER. Ledger is a group of accounts which are systematically categorized
into asset, liability, equity, revenue and expense accounts.
c. Summarizing is the preparation of financial statements. Worksheet facilitates the
preparation of balance sheet and income statements. Trial balance is a list of all
accounts with their corresponding balances, the total of debit and credit must be
equal.

SIGNIFICANCE AND NECESSITY OF ACCOUNTING INFORMATION/

USERS OF ACCOUNTING INFORMATION

1. Investors. The providers of risk capital and their advisers are concerned with the
risk inherent in and return provided by their investments. They need information
to help them determine whether they should buy, hold or sell their investments.
2. Employees, they are interested in information which enables them to assess the
ability of the entity to provide remuneration, retirement benefits and employment
opportunities.
3. Lenders. They are interested in information which enables them to determine
whether their LOANS and interest thereon will be paid when due.
4. Suppliers and other trade creditors. These users are interested in information
which enables them to determine whether amounts owing to them will be paid on
maturity.
5. Customers have an interest in information about the continuance of an entity
especially when they have a long-term involvement with or are dependent on the
entity.
 6. Governments and their agencies are interested in the allocation of resources and
therefore the activities of the entity. These users require information to
REGULATE the activities of the entity, determine TAXATION policies and as a
basis for national income and similar STATISTICS.
7. Public, in general. Entities affect members of the public in a variety of ways. For
example, entities make substantial contributions to the local economy in many
ways including the number of people the employ and their patronage of local
suppliers.

SPECIALIZED ACCOUNTING SERVICES

1. Financial Accounting. Financial accountancy (or financial accounting) is the

field of accountancy concerned with the preparation of financial statements for
decision makers, such as stockholders, suppliers, banks, employees, government
agencies, owners, and other stakeholders. Financial capital maintenance can be
measured in either nominal monetary units or units of constant purchasing power.
[1]
The fundamental need for financial accounting is to reduce principal-agent
problem by measuring and monitoring agents' performance and reporting the
results to interested users.
2. Auditing. A systematic process of objectively obtaining and evaluating evidence
regarding assertions about economic actions and events to ascertain the degree of
correspondence between these assertions and established criteria and
communicating the results to the interested users.
3. Tax accounting. It includes the preparation of annual income tax returns and
determination of tax consequences of certain proposed business endeavors. The
CPA not infrequently represents the client in tax investigations. It also includes
formulation of tax strategies like tax avoidance.
4. Government accounting encompasses the process of analyzing, classifying,
summarizing and communicating all transactions involving the receipt and
disposition of government funds and property and interpreting the results thereof.
The focus of government accounting is the custody and administration of public
funds.
5. Management accounting. Management accounting or managerial accounting is
concerned with the provisions and use of accounting information to managers
within organizations, to provide them with the basis to make informed business
decisions that will allow them to be better equipped in their management and
control functions. Management Accounting is "the process of identification,
measurement, accumulation, analysis, preparation, interpretation and
communication of information used by management to plan, evaluate and control
within an entity and to assure appropriate use of and accountability for its
resources. Management accounting also comprises the preparation of financial
reports for non-management groups such as shareholders, creditors, regulatory
agencies and tax authorities" (CIMA Official Terminology).
6. Accounting (information)system. The set of formal procedures by which data are
collected, processed into information and distributed to users. An accounting
 information system (AIS) is the system of records a business keeps to maintain
its accounting system. This includes the purchase, sales, and other financial
processes of the business. The purpose of an AIS is to accumulate data and
provide Cost accounting. In management accounting, cost accounting establishes
budget and actual cost of operations, processes, departments or product and the
analysis decision makers (investors, creditors, and managers) with information.
7. of variances, profitability or social use of funds. Managers use cost accounting to
support decision-making to cut a company's costs and improve profitability. As a
form of management accounting, cost accounting need not to follow standards
such as GAAP, because its primary use is for internal managers, rather than
outside users, and what to compute is instead decided pragmatically. Cost
accounting is an approach to evaluating the overall costs that are associated with
conducting business. Generally based on standard accounting practices, cost
accounting is one of the tools that managers utilize to determine what type and
how much expenses is involved with maintaining the current business model. At
the same time, the principles of cost accounting can also be utilized to project
changes to these costs in the event that specific changes are implemented.
8. Accounting education. Practice in education or the academe shall constitute in a
person in an educational in institution which involve teaching of accounting,
auditing, management advisory services, the accounting aspect of finance,
business law, taxation, and other technically related subjects.

BUSINESS ORGANIZATIONS

1. FORMS OF BUSINESS ORGANIZATION

a. Sole proprietorship
b. Partnership. It is a contract of two or more persons who bind themselves to
contribute money, property or industry to a common fun with the intention of
dividing profits among themselves. Two or more persons may also form a
partnership for the exercise of a profession.
c. Corporation. 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.

2. TYPES OF BUSINESS ORGANIZATION

a. Service concern. These types of business provide services to customers. Example:

MERALCO, PLDT, MRT, Victory Liner, Hospitals.
b. Merchandising business. The traders or merchandisers purchased goods and sell
them to customers. SM supermarket and department stores.
c. Manufacturing business. Manufacturing companies buy raw materials and convert
them into a finished product. Toyota, Coca-Cola, Colgate- palmolive.
FINANCIAL STATEMENTS

1. Income statements. A formal statement showing the FINANCIAL

PERFORMANCE of an entity for a given period of time. The financial
performance of an entity is primarily measured in terms of the level of income
earned by the entity through the effective and efficient utilization of its resources.
Sources of INCOME:

a. Sales of merchandise to customers.

b. Rendering of services.
c. Use of entity resources. Includes interest, rent, royalty and dividend income.
d. Disposal of resources other than products. Include gain on sale of investments,
gain on sale of property, plant and equipment and gain on sale of intangible
assets.

COMPONENTS OF EXPENSE:

a. Cost of Sales or Cost of goods sold.

i. Cost of sales of merchandising concern:

Beginning inventory:
ADD: Net purchases {[gross purchases + freight in] –[purchase returns
and allowances, purchase discounts]}
= GOOD AVAILABLE FOR SALE
LESS: Ending inventory
= COST OF SALES

b. Distribution costs or selling expenses.

b. Administrative expenses. Office salaries expenses of general executives and of

the general accounting and credit departments.

b. Other expenses are those expenses which are NOT DIRECTLY related to the
selling and administrative function.

b. Income tax expense.

2. Statements of comprehensive income. The statement of comprehensive income

starts with the profit or loss as shown in the income statement plus or minus the
components of other comprehensive income. The purpose of this statement is to
provide more comprehensive information of financial performance more broadly
than the income as traditionally computed.
 2. Balance sheet/ statements of financial position. Formal statements showing the
three elements comprising financial position, namely assets, liabilities and equity.

2. Statements of cash flows. Show the Cash INFLOWS and OUTFLOWS {receipts
and disbursements} ACTIVITIES:

a. Operating. Cash inflow from sale of merchandise and rendering of services.

b. Investing. Cash outflow to acquire land and building.
c. Financing. Cash flows involving transactions with creditors and owners.

5. Statements of changes in owner’s equity/capital. Basic statement that shows the

movements in the elements or components of the shareholders’ equity or capital.
Includes: net income for the period, additional investments of the owners,
withdrawals of owners or dividend paid to stockholders.

5. Notes, comprising a summary of significant accounting policies and other

explanatory notes.

PRINCIPAL CHARACTERISTICS OF FINANCIAL STATEMENTS (according

to conceptual framework)

A. PRIMARY QUALITIES. Relate to CONTENT of financial statements.

1. Relevance. The capacity of information to make a difference in a decision by

helping users form prediction about the outcome of past, present and future
events, or confirm and correct prior expectation. Capacity of the information to
INFLUENCE a decision. INGREDIENTS:

a. Predictive value.
b. Feedback value.
c. Timeliness.

2. Reliability is the degree of confidence users place upon the truthfulness of the
representation in the financial statements. The quality of information that assures
users that the information is free from bias and errors, and faithfully represents
what it purports to represent. FACTORS that enhance the reliability of financial
statements.

a. Faithful representation. It is synonymous with verifiability or objectivity.

b. Substance over form. The economic substance of transactions and events are
usually emphasized when economic substance differs from legal form. An
example is when the lessee leased property from lessor. The terms of the lease,
among others, provide that the lease TRANSFER OWNERSHIP of the asset to
the lessee by the end of the lease term.
 In legal form, the contract is a lease as popularly understood. But in
SUBSTANCE, in reality, if the transfer of ownership provision is to be
considered, the REAL INTENT of the parties is an INSTALLMENT
PURCHASE of property by the lessee from the lessor. Accordingly, the
lease shall be accounted for as a finance lease. Thus, the lessee shall
record the finance leases as and asset and a liability. The periodic rental is
conceived as an installment payment representing interest and principal.

c. Neutrality. It must be free from bias. PRINCIPLE OF FAIRNESS.

c. Conservatism. Under it, when alternatives exist, the alternative which has the least
effect on equity should be chosen. Managers, investors and accountants have
generally preferred that possible errors in measurement be in the direction of
understatement rather that overstatement of net income and net assets{total assets-
total liabilities} Synonymous to PRUDENCE. Expressions of conservatism and
prudence.

i. Anticipate no profit and provide for probable and estimable loss.

ii. In the matter of income recognition, the accountant takes the position that no
matter how sure the businessman might be in capturing the bird in the bush, he,
the accountant, must see it in the hand.
iii. Don’t count your chicks until the eggs hatch.

e. Completeness. It requires that relevant information shall be presented in a way

that facilitates understanding and avoids erroneous implication. Completeness is
the result of the adequate disclosure standard or the principle of full disclosure.
The accountant shall disclose a MATERIAL fact known to him which is not
disclosed in the financial statements but disclosure of which is necessary in order
that the statements would not be misleading.

B. SECONDARY QUALITIES. It relates to the PRESENTATION of financial

statements.

1. Understandability. The information should be presented in a form and expressed

in terminology that a user understands. But the complex economic activities make
it impossible to reduce the financial information to the simplest terms.
Accordingly, users are assumed to have a reasonable knowledge of the complex
economic activities and accounting and a willingness to study the information
with reasonable diligence.
2. Comparability. The ability to bring together for the purpose of noting points of
likeness and difference.

a. Intracomparability/horizontal comparability- within the entity, from one period to

another.
b. Intercomparability/dimensional comparability between and across entities.
 Implicit in the qualitative characteristic of comparability is the principle of
consistency. This principle requires that the accounting methods and practices
should be applied on a UNIFORM basis from period to period. For example,
the use of First in, first out (FIFO) in 2010, and the entity will use Average
Method of accounting inventory in 2011, and in 2012, the use of FIFO method
again. It is inconsistent of application of accounting methods, there will be no
comparability.
However, it is inappropriate for an entity to leave its accounting policies
unchanged when more relevant and reliable alternative exist.
An important implication of comparability is that users are informed of the
accounting policies employed, any changes in those policies and the effects of
such changes.

ACCOUNTING CONTSTRAINTS

1. Timeliness. Timeliness requires that the accounting information must be

available or communicated early enough when a decision is to be made.
Information furnished after a decision has been made is of no value. To provide
information on a timely basis it may often be necessary to report before all aspects
of a transaction or event are known, thus impairing reliability. Conversely, if
reporting is delayed until all aspects are known, the information maybe highly
reliable but of little value to users who have to make decisions in the interim.
2. Cost benefit. It is a consideration of the cost incurred in generating information
against eh benefit to be obtained from having the information. The benefit derived
from the information should EXCEED the cost incurred in obtaining the
information.
3. Materiality. Materiality is really a quantitative threshold constraint linked very
closely to the qualitative characteristic of relevance. The relevance of information
is affected by its nature and materiality.

Materiality is a practical rule in accounting which dictates that strict adherence to

GAAP is not required when the items are NOT SIGNIFICANT ENOUGH to
affect the evaluation, decision and fairness of the financial statements. This
concept is also known as the DOCTRINE OF CONVENIENCE.
INFORMATION IS MATERIAL IF IT’S OMISSION OR MISSTATEMENTS
COULD INFLUENCE THE ECONOMICE DECISION OF THE USERS
TAKEN ON THE BASIS OF THE FINANCIAL STATEMENTS. For example,
small expenditures for tools are often expensed immediately rather than
depreciated over their useful lives to save clerical costs of recording depreciation
because the effect on the financial statements is not large enough to affect the
economic decision.
Another example is the common practice of large entities of rounding amounts to
the nearest thousand pesos in their financial statements. Small entities may round
 off to the nearest peso. When all payments out of petty cash are debited to
miscellaneous expense, materiality is applied. FACTORS:

a. Size of an item.
b. Nature of the item. An item may be inherently material because by its very nature
it affects economic decision. For instance, the discovery of a P20000 bribe is a
material event even for a very large multibillion entity.

4. Balance between relevance and reliability. There is tradeoff between providing

relevant information but subject to uncertainty, for example, the fair value of trading
securities and available for sale investment, and providing reliable information but not
necessarily relevant information, for example, the historical cost of such investment.

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The 'basic accounting equation' is the foundation for the double-entry bookkeeping
system. For each transaction, the total debits equal the total credits.

Assets = Liabilities + Capital [1]

In a corporation, capital represents the stockholders' equity.

How it works

For example: A student buys a computer for $945. This student borrowed $500 from his
best friend and saved another $445 from his part-time job. Now his assets are worth
$945,liabilities are $500, and equity $445.

The formula can be rewritten:

Assets - Liabilities = (Shareholders or Owners equity or Capital)[1]

Now it shows owner's interest is equal to property (assets) minus debts (liabilities). Since
in a company owners are shareholders, owner's interest is called shareholder's equity.
Every accounting transaction affects at least one element of the equation, but always
balances. Simplest transactions also include:[2]
Transaction Shareholder's
Assets Liabilities Explanation
Number Equity
Issuing stocks for cash or other
1 6,000 + 6,000
assets
+
Buying assets by borrowing
2 10,000 10,000 money (taking a loan from a
+
+ bank or simply buying on credit)
Selling assets for cash to pay off
3 900 900 liabilities: both assets and
−
− liabilities are reduced
Buying assets by paying cash by
4 1,000 400 + 600 shareholder's money (600) and
+
+ by borrowing money (400)

5 700 + 700 Earning revenues

+
Paying expenses (e.g. rent or
6 200 − 200
professional fees) or dividends
−
Recording expenses, but not
7 100 − 100
+ paying them at the moment

8 500 500 Paying a debt that you owe

−
−
Receiving cash for sale of an
asset: one asset is exchanged
9 0 0 0
for another; no change in assets
or liabilities

These are some simple examples, but even the most complicated transactions can be
recorded in a similar way. This equation is behind debits, credits, and journal entries.

This equation is part of the transaction analysis model, for which we also write

Owners equity = Contributed Capital + Retained Earnings

Retained Earnings = Net Income − Dividends

and

Net Income = Income - Expenses

The equation resulting from making these substitutions in the accounting equation may
be referred to as the expanded accounting equation, because it yields the breakdown of
the equity component of the equation.