OVERVIEW OF ACCOUTING

Accounting is the “process of identifying, measuring, and communicating economic information to permit
informed judgments and decisions by users of the information”.

Important Activities in Accounting

1. Identifying – analyzing events and transactions to determine whether or not they will be recognized

Recognition – including the effects of an accountable event through journal entry

Accountable Events Non-accountable Events

Accountable Events
 one that affects economic activities not recognized as accounting; but if it has accounting

Non-accountable Events
 relevance it is recorded in memorandum entry

Type of Events or Transactions

• External Events – involve external party

i. Exchange (reciprocal transfer) – give and receive

ii. Non-reciprocal transfer – give but not receive (e.g., donation, tax)
iii. External event other than transfer – changes in economic resources or obligations but no transfer
happened (e.g., price levels, technological changes)

• Internal Events – do not involve external party

i. Production – resources are transformed into finished goods
ii. Casualty – unanticipated loss

2. Measuring – assigning numbers in monetary terms

- FS are prepared using mixture of costs and values.
- FS are mixture of fact and opinion

• Valued by Opinion – measurement affected by estimates

• Valued by Fact – measurement not affected by estimates

3. Communicating – transferring economic data into useful accounting information for dissemination
and interpretation

Three Aspects of Communicating Process in Accounting:

1. Recording – writing the accountable events through journal entry

2. Classifying – grouping of similar items into their respective classes through posting
3. Summarizing – expressing in condensed form which include preparations of accounting reports
NOTE: Interpreting the processed information is computing of financial statement ratios.

BASIC PURPOSE OF ACCOUNTING

• To provide information useful in making economic decisions

• Economic entity – combination of people and property that uses economic resources to achieve certain
goals.

Types of economic entity:

➢ Not-for-profit entity
➢ Business entity

Economic activities are activities that affect the economic resources, obligations and the equity of an economic
entity. Economic activities involve:

1. Production 3. Consumption 5. Savings

2. Exchange 4. Income Distribution 6. Investments

Types of Information Provided by Accounting

1. Quantitative Information – numbers, quantities or units

2. Qualitative Information – words or description form; usually found in notes
3.Financial Information - money

Types of Accounting Information Classified to User’s Need

1. General Purpose Accounting Information – common need of most statement users

2. Special Purpose Accounting Information – specific needs of particular users

The practice of accounting requires the exercise of:

Creative Thinking
Creative Thinking
 using imagination and insight
 identifies alternative solutions

Critical Thinking
 logical analysis
 evaluates alternative solutions

ACCOUNTING CONCEPTS - principles upon which the accounting process is based (accounting assumptions
or accounting theory)

• Double-entry system - debit and credit

• Going Concern Assumption – assumes continual operation and not expect to end
• Separate Entity – owners9 personal transactions are separated from the business
• Stable Monetary Unit – accountable events are expressed in terms of common unit
- purchasing power is considered stable regardless of instability
• Time Period – life of reporting period of entity, usually 12 months
 Calendar Year – starts at January 1
 Fiscal Year – starts on a date other than January 1
• Materiality Concept – a judgment that is based on its size and nature
• Cost-benefit – cost must equal benefit
• Accrual Basis – the effects of transactions are recognized when they occur and not as cash is received or
paid
• Historical Cost Concept (Cost Principle) – the asset value is based on the acquisition cost
• Concept of Articulation – all the components of a complete set of financial statements are interrelated
• Full Disclosure Principle – including enough details to make information understandable
• Consistency Concept – using the same accounting principle of different periods
• Matching –
costs are recognized as expenses when the related revenue is recognized
• Entity Theory – proper income determination (A=L+C) – income statement
• Propriety Theory – proper valuation of assets (A-L=C) – balance sheet
• Residual Equity Theory – applicable when there are two classes of shares issued (ordinary and preferred
(A-L- Preferred Shareholder’s Equity=Ordinary Shareholders Equity)
•Fund Theory –custody and administration of funds
(cash inflows - cash outflows=funds)
• Realization – converting non-cash assets into cash or claims for cash
• Prudence (Conservatism) – use of caution when making estimates; does not allow deliberate assets’
understatement or liabilities’ overstatement (e.g., cookie jar reserve); choosing least effect on equity

EXPENSE RECOGNITION PRINCIPLES

• Matching Concept (Direct Association of Costs and Revenues) – cost that are directly related to the
revenue are recognized as expenses in the same period
• Systematic and Rational Allocation – cost that are not directly related to the revenue are recognized
are assets first and are recognized as expenses when consumed using some method of allocation (e.g.,
depreciation, amortization)
• Immediate Recognition – cost that do not meet or ceases to meet the definition of assets are expensed
immediately (e.g., casualty and impairment losses)

COMMON BRANCHES OF ACCOUNTING

• Financial Accounting – focuses on general purpose financial statements

 Financial Statement (FS) – entity’s financial

position and results of its operations and are communicated to users
 Financial Report – FS plus other information to help in making efficient economic decisions and is
useful to external users. Objectives of financial reporting is to provide information:
1. Entity’s economic resources, claims and changes
2. Useful in assessing the entity’s management stewardship
• Management Accounting – communication of information for use by Internal users
• Cost Accounting – systematic recording and analysis of cost of materials, labor and overhead incident to
production
• Auditing – evaluating with established criteria and express opinion to ensure fairness and reliability
• Tax Accounting – preparations of tax returns and rendering of tax advice
• Government Accounting – custody of public funds, its purpose, and the responsibility and accountability of
entrusted individual
• Fiduciary Accounting – handling accounts managed by a person for the benefit of other
• Estate Accounting – handling accounts for fiduciaries who wind up the affairs of deceased person
• Social Accounting – communicating the social and environmental effects of an entity9s economic
actions to the society
• Institutional Accounting – for non-profit entities other than government
• Accounting Systems – installation of accounting procedures for the accumulation of financial data and
designing of accounting forms for data gathering
• Accounting Research – careful analysis of economic events and other variables to understand their impact of
decisions

Bookkeeping – recording the account or transaction of an entity

– ends with the preparation of trial balance
– does not require interpretation
Accountancy – profession or practice of accounting either public or private practice

PHILIPPINE ACCOUNTANCY ACT OF 2004 (R.A. 9298)

Sectors in the Practice of Accountancy

1. Practice in Public Accountancy – rendering service to more than one client on fee basis

2. Practice in Commerce and Industry – employment in private sector

3. Practice in Education/Academe – employment in educational institutions

4. Practice in Government – employment in government or controlled corporations

NOTE: 2 and 4 are considered private practice.

ACCOUNTING STANDARDS USED IN THE PHILIPPINES

• Philippine Financial Reporting Standards (PFRS) – Philippines GAAP is based on IFRS

PFRS is comprised of:

a. Philippine Financial Reporting Standards (PFRS)
b. Philippine Accounting Standard (PAS)
c. Interpretations Reporting standards is necessary to become comparable, avoid fraudulent reporting, and right
economic decisions.

Selection of appropriate accounting policies is the entity’s

management responsibility. However, the proper application of accounting principles is the accountant’s
responsibility.

ACCOUNTING STANDARD SETTING BODIES AND OTHER RELEVANT ORGANIZATION

1. Financial Reporting Standard Council (FRSC) – official accounting standard setting body of the
Philippine created under RA 9298
2. Philippine Interpretations Committee (PIC) – predecessor of FRSC which reviews the
interpretations of International Financial Reporting Interpretations Committee (IFRIS) for approval and adoption
by the FRSC
3. Board of Accountancy (BOA) – supervise the registration, licensure and practice of accountancy in the
Philippines
4. Securities and Exchange Commission (SEC) – regulates corporations and partnership, capital and
investment marks, and the investing public
5. Bureau of Internal Revenue (BIR) – administers the provisions of the National Internal RevenueCode
6. Cooperative Development Authority (CDA) – influences the selection and application ofaccounting
policies by cooperatives

NOTE: Accounting policies prescribes by a regulatory body are sometimes referred to as regulatoryaccounting
principles.

International Accounting Standards Board (IASB) – standard setting body of the IFRS Foundationwith the
main objectives of developing and promoting global accounting standards.

Standards issued:
• International Financial Reporting Standards (IFRS)
•International Accounting Standards (IASs)
•Interpretations

The move to IFRS was primarily brought by the increasing acceptance of IFRSs world-wide and increasing
internalization of business thereby increasing the need for a common financial reporting standards that minimize,
if not eliminate, inconsistencies of financial reporting among nations

CONCEPTUAL FRAMEWORK AND REPORTING STANDARD

Prescribes the concept for general purpose financial reporting to assist IASB in developing standards, assist
prepares in developing consistent accounting policies when no standard applies to a transaction and assist all
parties in understanding and interpreting standards.

CONCEPTUAL FRAMEWORK

• Provide foundation for the development of standards that promote transparency, strengthenaccountability, and
contribute to economics efficiency
• Do not provide requirements for specific transactions or events
• Conceptual framework is not a standard. Any conflict between the two, standard will prevail.
• Use the hierarchy of standard for guidance in authoritative status. (See PAS 2 for reference)
• This can be revised but not automatically result to change of Standards not until the IASB dueprocess
• Scope of Conceptual Framework:
OBJECTIVE OF FINANCIAL REPORTING
• Foundation of the Conceptual Framework
• Provide financial information that is useful to primary users in making decisions about providing resources to
the entity.
• Decisions of primary users are based on assessment of an entity’s
prospect for future net inflows and management stewardship
.
Hence, users need information of entity9s financial position, financial performance, and other changes in financial
position, and assets’ utilization.

General Purpose Financial Reporting

 Caters most of the common need of most primary users
 Do not directly show the value of entity but only information that help users estimates entity value.
 Providing information requires estimates and judgment

1. Financial Position – information on resources (assets) and claims (liabilities and equity)

 This can help users in assessing entity’s:

• Liquidity and solvency – able to pay short and long-term obligations, respectively
• Needs for additional financing
• Management9s stewardship

2. Changes in economic resources and claims – information on financial performance and other
events or transaction that led to the said change

QUALITATIVE CHARACTERISTICS
Identifies the most useful information to primary users in making decisions using entity’s financial report

Applicable to information in FS and to financial information provided in other ways

1. Fundamental Qualitative Characteristics – information useful to users

a. Relevance – can affect decision of users
•Predictive Value –making predictions using past info
• Confirmatory Value – confirming previous decisions

 Materiality
• Information is material if omitting or misstating it could influence primary users9 decision
• Entity-specific
• IFRS Practice Statement 2 Making Materiality Judgments provide non-mandatory guidancecalled materiality
process.

Below are the four steps:

1. Cost-Benefit Principle. However, cost is not a factor when making materiality judgment.
2. Assess whether step 1 information could influence the user’s
decisions by:

Primary Users
➢ Existing and potential investors
➢ Lenders and creditors cannot demand specific information

Entity only provides the common needed data of most primary users

a. Items nature or size or both

b. Quantitative and qualitative factors

Quantitative factors – size of impact and can be assessed in relation to another amount percentage or a
threshold amount -– CF and the standard do not specify a quantitative threshold since it is a judgment

Qualitative factors – characteristic of item or context; (i) entity specific and (ii) external qualitative factors

No hierarchy among factors, but an entity normally assesses an item first in quantitative factors:
➢ If it is quantitatively material, no need to reassess qualitative factors.
➢ If not quantitatively material, needs to reassess qualitative factors

3. Maximizes understandability to users by organizing FS draft

4. Reviewing the draft allows overview. An item might be immaterial on its own, but might be material in
conjunction with other FS information

b. Faithful Representation – true, correct and complete depiction (when an economic phenomenon’s
substance differs from its legal form (i.e., substance over form), it requires depiction)
➢ Completeness – must provide all information needed in understanding
➢ Neutrality – not manipulated or without bias
➢ Free from Error – accurate but not precise; supported by prudence (use of caution when making judgment)

2.Enhancing Qualitative Characteristics – enhance usefulness of information

a. Comparability – to identify similarities and differences of different information through intra-comparability
or inter-comparability
b. Verifiability – different users should reach a general agreement
i. Direct verification – can be observe directly (e.g., counting of cash)
ii. Indirect verification – redo the methodology used by the entity
c. Timeliness – available to users on time
d. Understandability – presented in clear and concise manner but does not mean excluding complex matter

Applying Qualitative Characteristics

➢ Information must be both relevant and faithfully represented
➢Enhancing qualitative information cannot make irrelevant information useful
➢ One enhancing qualitative characteristic may be sacrificed to maximize another
➢ Cost constraint – pervasive constraint; providing information has cost; cost must equal benefits

FINANCIAL STATEMENTS AND THE REPORTING ENTITY

• The objective of general purpose financial statements is to provide financial information about the
reporting entity’s financial position, financial performance, and other statements and notes
• Reporting Period
• Information must be comparative, forward-
looking, and entity’s perspective
• Going concern assumption – an underlying assumption that is
based on management’s decision
• Reporting Entity – can be single or group or combination of two or more entities

An entity controls another entity:

1. Parent – controlling entity
2. Subsidiary – controlled entity

➢ Consolidated Financial Statement – combined report of parent and subsidiary

➢ Unconsolidated Financial Statement – report from parent only
➢ Individual Financial Statement – report from subsidiary only
➢ Combined Financial Statement – report of two or more entities not linked by parent-subsidiary

ELEMENTS OF FINACIAL STATEMENTS

• Assets – 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.
- ability to prevent others from accessing the benefits of controlled resources
- control normally stems from legally enforceable rights (e.g., ownership or legal title). However, ownership is not
always
• Liability – present obligation of the entity to transfer an economic resource as a result of past events
-transfer of economic benefits need not be certain

a. Legal obligation – result from contact, legislation, or other law of operation

b. Constructive obligation – result from entity’s action (e.g., warranty, environmental damages)

Executory Contract – a contract that is equally unperformed by both parties or have partially fulfilled with equal
extent; combined right or obligation
Executed Contract – fulfilled by other party

• Equity – residual interest after deducting assets from liabilities

Reserves - amount set aside to protect the entity’s creditors or shareholders from losses

• Income – revenue; increase in assets or decrease in liabilities that result in increase in equity
• Expenses – costs; decrease in assets or increase in liabilities that result in decrease in equity
NOTE: The new conceptual framework removes the notion of expected and probability of economic flow, and
reliable measurement

Financial Position – balance sheet; assets, liabilities and equity

Financial Performance – income statement; income and expenses

RECOGNITION
• Items are recognized if it meets the two criteria:
➢ Meets the definition of financial element; and
➢ Provides useful information (relevance and faithfully represented information)
• An asset (liability) can exist even if producing (transferring) benefits has low probability, but can affect the
recognition, how it is measured, what and how information is provided
• Unresolve dispute of asset or liability will mostly affect the recognition
•Existence uncertainty and low probability of an inflow or outflow of economic benefits may result in but does not
automatically lead to the non-recognition of asset or liability. Other factors should be considered.

• Measurement uncertainty
➢ Exist if the asset or liability needs to be estimated
➢ High level of measurement uncertainty does not necessarily lead to non-recognition if it provides relevant
information and is clearly and accurately described and explained
➢ However, it can lead to non-recognition if making estimate is exceptionally difficult or subjective(can affect
faithful representation) or especially if one or more of the circumstances exist:

▪ Exceptionally wide range of possible outcome and is difficult to estimate

▪ Highly sensitive to small changes
▪ Exceptionally subjective allocations of cash flows that do not relate solely to the asset or liability being measured

DERECOGNITION
• Removal of previously recognized asset or liability when the item no longer meets its definition
• Derecognizes asset or liability that have expired, consumed, collected, fulfilled or transferred and continues to
recognize any assets or liabilities that have retained after derecognizing

Unit of Account is the right or the group of rights, the obligation or the group of obligations, or the group of rights
and obligations, to which recognition criteria and measurement concept are applied

MEASUREMENT
• Measurement basis is needed since recognition requires quantifying item in monetary terms.