ACCOUNTING AND ITS ENVIRONMENT

At the end of this module, the students should be able to define

Accounting and explain its role and importance in Business, know
the concept of business model and activities of business model and
the different forms as well as the advantages and disadvantages of
each form. He/she must be able to differentiate and understand the
phases of accounting. Moreover, the students will be able to
explain and apply the fundamental Accounting concepts and
principles.
 
Accounting is often intimidating to students because it involves math
and unfamiliar terminology. Do you feel intimidated? Are you nervous
taking this course? Don't worry I know this course maybe difficult to
understand but I will try to make it easier by relating these bunch of concepts into our daily
lives.
 
When we you heard the word accounting what comes in your mind? Do you think it's all about
numbers? People usually have this impression that if you are good in Mathematics you will easier
grasp the concepts of this course. But allow me to spill the truth. Accounting involves basic math
operations such as addition, subtraction, multiplication and division. It is seldom that you will have to
use complex mathematical equations/formula. In studying this course, your good analytical skills will
help you to understand and integrate concepts underlying accounting.
 
In Accounting, your why’s and how’s are very essential to better comprehend the topics.
 
Accounting doesn't require you to memorize as much information as other subjects do. It does
however require you to understand "WHY." Accounting is all about "WHY." As you read your textbook
discover the "WHY" in what you're reading. Try to understand the logic behind what is being taught.
 
Once you understand the "why", it's important to discover the "how". It's not enough to
understand why an accounting principle or concept works, if you can't apply it. You must
understand how accounting concepts work and be able to apply them.
 
Okay, Let's do this!
 
Do you have any idea what accounting really means?

Before drilling down to other aspects of accounting and the importance of accounting, let us
understand what does it means.

WHAT IS ACCOUNTING? 

 
 It is a system that measures business
activities, processes that information into
reports and communicates the results to
the decision makers. For this reason, it is
called the language of business.
 
 It is the process of recording financial
transactions pertaining to a business. The
accounting process includes summarizing,
analyzing and reporting these transactions to
oversight agencies, regulators and tax
collection entities. The financial statements
 used in accounting are a concise summary of financial transactions over an accounting
period, summarizing a company's operations, financial position and cash flows. 
 

No business can operate in long period of time without knowing how much it was earning and how
much it was spending. Accounting helps to provides the financial picture of a business.

DEFINITION OF ACCOUNTING
 
 
 
 
 
 
 
 
 
 
Accounting may be defined as a service activity, as an information system, as a process and as an art.
 
 As a service activity. It aims to provide quantitative information, primarily financial in nature,
about economic entities (businesses) that is intended to useful in making economic decisions.
 
 As an information System. It measures, processes and communicates financial information
about economic entity.

 As a process of identifying, measuring and communicating economic information to permit

informed judgements decisions by the users of information.

 As an 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.

FUNDAMENTAL BUSINESS MODEL

 
Gleaning from the illustration above, you will see how a business structured to provide a customer
proposition. Note that the business model is built on (5) activities:

1. The investors provide the required capital for the business. The cash investment will
be held in a bank account.

2. The cash can be converted into another type of asset that will be used in the business.
Portion of this may be spent in operating costs.

3. Once the business resources were combined, this provides the basis for producing the
products or services.

4. The sale of a product or service will generate an asset called receivable. This asset
once collected will produce a cash inflow for the business.

5. Note that if there is an existing debt from the banks, the cash inflow from collections
will be used to provide the debt providers with interest. The remaining cash will be
send back to the cycle being converted into other assets or spent in operating cost.

TYPE OF BUSINESS
1. Service Business - A service type of business provides intangible products (products with no
physical form). Service type firms offer professional skills, expertise, advice, and other similar
products.

2. Merchandising Business - This type of business buys products at wholesale price and sells
the same at retail price. They are known as "buy and sell" businesses. They make profit by
selling the products at prices higher than their purchase costs. A merchandising business sells
a product without changing its form.

3. Manufacturing Business - Unlike a merchandising business, a manufacturing business buys

product with the intention of using them as materials in making a new product. Thus, there is
a transformation of the products purchased. A manufacturing business combines raw
materials, labor, and overhead costs in its production process. The manufactured goods will
then be sold to customers.

4. Raw Materials – Engage in growing or extracting raw material.

5. Infrastructure – Engage in selling and utilization of Infrastructure.

FORMS OF BUSINESS ORGANIZATION

1. Sole Proprietorship

A sole proprietorship is a business owned by only one person. It is easy to set-up and is the
least costly among all forms of ownership. The owner faces unlimited liability; meaning, the
creditors of the business may go after the personal assets of the owner if the business cannot
pay them. The sole proprietorship form is usually adopted by small business entities.

Still, the sole proprietorship is not without disadvantages, the most serious of which is its
unlimited liability. As a sole proprietor, you are responsible for all business debts. Should
these exceed the assets of your business, your creditors can claim your personal assets--
home, automobile, savings account, and investments. In other words, the law basically treats
 the business and the owner as one and the same. This uniform treatment also has important
tax implications. Partnerships and corporations may lessen their tax liability through a myriad
of business expenses and other tax avoidance techniques. These tax deductions may not be
applicable to a sole proprietorship. Also, the potential growth and reach of a sole
proprietorship pale in comparison with that of a corporation. Sole proprietorships also tend to
have more difficulty obtaining capital and holding on to key employees. This stems from the
fact that sole proprietorships generally have fewer resources and offer less opportunity for job
advancement. Thus, anyone who chooses the sole proprietorship should be prepared to be a
generalist, performing a variety of functions, from accounting to advertising.

Advantages

 The proprietor is the boss.

 It is easy to get started.
 The proprietor keeps all profits.
 Income from business is taxed as personal income.
 The proprietor can discontinue their business at will.

Disadvantages

 The proprietor assumes unlimited liability.

 The amount of investment capital you can raise is limited.
 The proprietor needs to be a generalist.
 Retaining high-caliber employees is difficult.
 The life of the business is dependent on the owners.

2. Partnership

A partnership is a business owned by two or more persons who contribute resources into the
entity. The partners divide the profits of the business among themselves.
In general partnerships, all partners have unlimited liability. In limited partnerships, creditors
cannot go after the personal assets of the limited partner.

Like sole proprietorships, the laws do not distinguish between the business and its owners.
The Partners should have a legal agreement that sets forth how decisions will be made, profits
will be shared, disputes will be resolved, how future partners will be admitted to the
partnership, how partners can be bought out, or what steps will be taken to dissolve the
partnership when needed. It’s difficult to think about a "break-up" when the business is just
getting started, but many partnerships split up at crisis times and unless there is a defined
process, there will be problems. They also must decide up front how much time and capital
each will contribute. Like the sole proprietorship, it is easy to start and the red tape involved is
usually minimal.

Advantages

• Two heads are better than one.

• It's easy to get started.
• More investment capital is available.
• Partners pay only personal income tax.
• High-caliber employees can be made partners.

Disadvantages

• Partners have unlimited liability.

• Partners must share all profits.
• The partners may disagree at times when it comes to making business decisions.
 • The life of the business is limited.

3. Corporation

A corporation is a business organization that has a separate legal personality from its owners.
Ownership in a stock corporation is represented by shares of stock.
The owners (stockholders) enjoy limited liability but have limited involvement in the
company's operations. The board of directors, an elected group from the stockholders,
controls the activities of the corporation.

Advantages

• Stockholders have limited liability.

• Corporations can raise the most investment capital.
• Corporations have unlimited life.
• Ownership is easily transferable.
• Corporations utilize specialists.

Disadvantages

• Corporations are taxed twice.

• Corporations must pay capital stock tax.
• Starting a corporation is expensive.
• Corporations are closely regulated by government agencies.

WHO ARE THE MSMEs?

MSMEs stands for Micro, Small, Medium Enterprises.

An MSME in the Philippines is defined as any business activity or enterprise engaged in industry, agri-
business and/or services that has: (1) an asset size (less land) of up to PhP100 million; and (2) an
employment size with less than 200 employees. Based on these categories, it is classified as micro,
small or medium regardless of the type of business ownership (i.e., single proprietorship, cooperative,
partnership or corporation).

Point of Difference MICRO SMALL MEDIUM

Assets 3M and below Above 3M to 15M Above 15M to 100M

No. of Workers 1 to 9 10 to 99 100 to 199

UNDERSTANDING BUSINESS ACTIVITIES

There are three main types of business activities: operating, investing, and financing. 

Operating

This activity involves the use of resources to design, produce, distribute and market goods and
services.
Business competes in the market to sell their goods or services created by operating activities.
Examples of operating activities:
• Purchasing
• Production
• Distribution
• Selling

Investing

This activity involves selection and management including disposal and replacement of long-term
resources that will be used to develop, produce or sell goods or services.

Examples of investing activities:

• Buying Land
• Acquiring other resources that are needed in the operation of the business

Financing

These are the methods an organization uses to obtain financial resources from financial markets and
how it manages these resources. Primary sources of financing for most businesses are owners and
creditors, such as banks and suppliers.

PURPOSE OF ACCOUNTING

Accounting enables transparency in the business and demonstrates investors / shareholders how the
business operates, its assets, liabilities, equity, revenues, cash flow, and lawsuits.

Its purpose is to provide the information that is needed for making sound judgements and business
decisions.

Systematic Recording

Communicate Financial Status

Purpose of Helps in decision making

Accounting
Ensure control of assets

Aids in planning future activities

Comply with laws and regulations

PHASES OF ACCOUNTING

Recording Classifying Summarizing Analyzing

 Recording is a basic phase of accounting that is also known as bookkeeping. In this phase,
all financial transactions are recorded in a systematical and chronological manner in the
appropriate books. These are the documents and books involved in preparing financial
statements.
 Classifying involves sorting and grouping similar items under the designated name,
category or account. This phase uses systematic analysis of recorded data in which all
transactions are grouped in one place. For example, "travel expenses" might be a category
that accountants use to classify expenses relating to company travel. The term “ledger”
refers to the book in which classifications are recorded.
 Summarizing phase of accounting involves summarizing the data after each accounting
period, such as a month, quarter or year. The data must be presented in a manner which is
easy to understand and use by both external and internal users of the accounting
statements. 
 Analyzing/interpreting is process in concerned with interpreting financial data, and is a
critical tool for decision-making. This final function interprets the recorded data in a manner
which allows end-users to make meaningful judgments regarding the financial conditions of
a business or personal account, as well as the profitability of business operations. This data
is then used to prepare future plans and frame policies to execute financial plans.

FUNDAMENTAL CONCEPTS
1. Entity Concept

Under this concept, all the transactions associated with a

business must be separately recorded from those of its owners
or other businesses. 

2. Periodicity Concept

Under this concept periodicity concept are generated over

relatively short periods of time for example, a year or a
quarter, so that performances can be measured and compared
to each interval.
 3. Stable Monetary Unit Concept

This concept assumes that the value of the peso

is  stable over time. This concept essentially allows accountants
to disregard the effect of inflation -- a decrease, in terms of real
goods, of what a peso can purchase.

4. Going Concern Concept

Going concern is an accounting term for a company

that has the resources needed to continue
operating indefinitely until it provides evidence to
the contrary. 

WHAT IS GAAP? (Generally Accepted Accounting Principles)

 These are set of rules, conventions, and procedures that govern how accountants measure,
process and communicate financial information.

 Ensures that consistent accounting procedures are followed in recording the events that arise
from business transaction and as well as in the preparation of the financial statements.

The General Acceptance of an Accounting Principle usually depends on how well it meets three
criteria:

1. Relevance - refers to how helpful the information is for financial

decision- making processes. 

2. Objectivity - This means that the accounting information should be

independent. It should be prepare keeping all the bias aside. 

3. Feasibility – A principle has to be implemented without undue

complexity or cost.

BASIC PRINCIPLES
 a. Objectivity principle - states that the financial statements a company produces must be based on
solid evidence. The aim of this principle is to ensure that management and accounting do not allow
any personal opinions or biases from making their way into the financial statements.

b. Historical Cost - states that businesses must record and account for most assets and
liabilities at their purchase or acquisition price.

c. Revenue recognition principle - states that companies should record their revenues when
they are recognized or earned.
d. Expenses recognition principle -states that expenses are recognized and matched in the
books in the same period as that of the revenues.

e. Adequate Disclosure - is the concept that the complete package of an entity's financial
statements and accompanying disclosures should provide all key information needed by
users to understand the entity's financial situation.

f. Materiality - defines the threshold or cutoff point after which financial information becomes
relevant to the decision-making needs of the users.

g. Consistency principle - refers to the accounting principle that requires an entity to apply the

same accounting methods, policies, and standards for preparing and reporting its  financial
statements.

How can you apply accounting in real-life situations?

Come to think of it when cooking something at home, the first thing we often do is check if
we have the ingredients we need. If not, the next thing we do is list down all the items that
we will purchase in the supermarket. Then, after you get all the things you need, you
proceed to the cashier to pay them the total price of your groceries.

Finally, you thoroughly count your change to make sure that there is no overage or shortage. If you
find any, you are most likely going to approach the sales person to correct the error.

We’re you able to identify which parts were actions you did were related to accounting?

If yes, then good job!

But if not, then here’s a simple explanation on how groceries are related to accounting.

Summarizing; by looking at your kitchen, you were already summarizing which items you will buy and
which ones you will not.

Analyzing; the act of counting your change to know whether they gave you too much or too little is
like an accountant investigating if their business is receiving the correct amount of cash or revenue.

Reporting; lastly, reporting is when you try to communicate your data to other parties. Hence, when
you explained to the cashier that she gave you too much or too little change, you are reporting to her
based on how you analyzed what you previously summarized.

With every choice we make, whether for major or minor decision, we are unconsciously using the
principles of accounting. Hence, it is an inescapable part of everybody’s lives. Nevertheless, there are
also other ways that you could apply accounting to make your life better.

----------------------------Nothing follows-----------------------------
Reference: Ballada, Win. (2019). Basic Financial Accounting and Reporting: Domdane Publishers and
Made Easy Books

Additional video reference: https://www.youtube.com/watch?v=azVuusaDZ-U&t=36s

Jeremiah 29:11 “For I know the thoughts that I think toward you, says the LORD, thoughts of
peace and not of evil, to give you a future and a hope.”