CHAPTER 1: THE NATURE OF ACCOUNTING AND ITS BUSINESS ENVIRONMENT

WHAT IS ACCOUNTING?
Accounting is the systematic process of measuring and reporting relevant financial information about
the activities of an economic organization or unit. Its underlying purpose is to provide financial information. It
is capable of being expressed in monetary terms.

The 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, transaction, and events,
which are in part at least of a financial character, and interpreting the result thereof.

The Philippine Institute of Certified Public Accountants (PICPA) defines accounting as 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.
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NATURE OF ACCOUNTING
1. Accounting is a systematic process
Process is the series of actions that produce something or that lead to a particular result. The
performance of the four aspects of accounting leads to communicating to its users the relevant
financial information needed by the parties interested.
2. Accounting is an art
Accountants have creative analysis base from the Accounting Policies, Standards, and Procedures.
3. Accounting is a service activity
Accounting is a work or occupation that provides financial information.
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FOUR ASPECTS OF ACCOUNTING
1. Recording - writing down of business transactions chronologically in the books of account as they
transpire.
Journal - Books of Original Entry
 General Journal
 Special Journal
2. Classifying - sorting similar and related business transactions into the three categories, the Assets, Liabilities,
and Owners Equity.
3. Summarizing - preparing the financial statements
4. Interpreting - Auditor gives opinion on the financial statements.
4 Auditors(CPA) Opinion
1. Qualified Opinion - financial records have not followed GAAP in all financial transactions
2. Unqualified Opinion - clean, best opinion
3. Adverse Opinion - Material mis-statement
4. Disclaimer’s Opinion - No Opinion from Auditor

BUSINESS TRANSACTIONS
Activities / Events occuring during a given period of time that affects the daily business operations.

Characteristics of Business Transactions (Monetary):

1. Sum certain of money
2. Supported by genuine source document (invoice, sale order, official receipt, etc.)
3. Affecting two fold elements of accounting.
Debit ~ Right Side ~ Value Received
Credit ~ Left Side ~ Value Parted
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HISTORY OF ACCOUNTING
 Started around 7500 BCE by Mesopotamians
 Accounting records were found in the Ancient Cities Babylon, Assyria, and Sumeria.
 Roman empire had access to detailed financial information as seen in the tablet of “ The Deeds of the
Divine Augustus”
Luca Bartolomeo de Pacioli - Father of Accounting
- introduced “Double-Entry Bookkeeping System”
- author of “Summa de Arithmetica, Geometria, Proportioni et
Proportionalita”
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BRANCHES OF ACCOUNTING
1. Financial Accounting
Financial accounting deals with the theoretical framework covering accounting principles and
concepts relative to measurement and valuation as applied to assets, liabilities, stockholder's equity,
retained earnings, revenue, and expense accounts in relation to the preparation and presentation of
financial statements. These financial statements include disclosure requirements as governed by the
generally accepted accounting principles (GAAP).

The financial information provided by financial accounting is used for decision making by both
internal and external users. Internal users include owners, shareholders, management, and employees
while external users include creditors, potential investors, and government agencies.

2. Management Accounting
The Institute of Management Accountants (IMA) defines management accounting as a profession
that involves partnering in management decision making, devising planning and performance
management systems, and providing expertise in financial reporting and control to assist management
in the formulation and implementation of an organization's strategy.
3. Government Accounting
Section 109 of Presidential Decree (PD) No. 1445 states that 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
agencies responsible in performing government accounting functions are the Commission of Audit
(COA), the Department of Budget and Management (DBM), and the Bureau of Treasury (BTr).

4. Auditing
Auditing is the examination and review of accounting reports in order to ascertain their fairness,
propriety, and reliability. The independent auditor's opinion provides reasonable assurance that the
financial statements under examination fairly present the company's financial position and results of
operation in accordance with the generally accepted accounting principles (GAAP).

5. Tax Accounting
Tax services provided by accountants include the preparation of monthly value added tax.
percentage tax, expanded withholding tax returns, quarterly and annual tax returns, and any other
taxes applicable to business. Accountants work closely with clients in order to avoid tax problems with
the Bureau of Internal Revenue (BIR) and other local agencies through proper tax compliance while
advising clients about ways and measures to minimize taxes.

6. Cost Accounting
Cost accounting includes the collection, determination, allocation, assessment, interpretation, and
control of cost data, particularly the cost of production in a manufacturing concern. The cost of
production includes the raw materials, direct labor. factory overhead, and all other costs involved
incident in each stage of production of the finished goods.

7. Accounting Education
Accounting education involves planned grading and formal teaching in an educational institution.
The professional accountant imparts knowledge to students enrolled in an accounting subject either in
basic accounting or in higher accounting subjects. Accountants in the academe usually take post
graduate studies to achieve the required tenure.

8. Accounting Research
Accounting research involves conducting a careful and diligent study aimed at discovering and
interpreting facts, revising accepted theories in the light of new facts, or the practical application of
such new or revised theories for the generation of a new knowledge. It includes collecting information
about a particular subject in order to decide and implement new standards in accounting, presenting
current events that might affect the profession, or discovering new theories that will have an impact
on existing accounting knowledge.
USERS OF FINANCIAL INFORMATION

Internal Users
Internal users are the primary users of financial information who are inside the reporting antity and are
directly involved in managing the company's daily operations. They are the decision makers who make the
strategic and operational decisions for the company.
1. Investors/ Owners/ Stockholders
These parties provide the financial resources to keep the business going. They decide whether to
invest or not depending on the estimated amount of income on the investment. Upon investment, they
would want to know the financial position or results of operation of their business investment.
2. Management
Organizational managers use financial information to set goals for their companies. Managers
evaluate their progress towards these goals and use financial data as a guide for future management
actions.
3. Employees
Although the employees are not directly involved in the decision making of the company, they
are nonetheless interested in the financial information of the company to determine if they have a future
in the company.

External Users
External users are secondary users of financial information who are parties outside the company. They
may not be directly involved in the company's operations but their decisions may significantly affect the
business entity.
1. Financial Institutions/ Creditors
Before extending credit, financial institutions use financial information to determine the capacity
of the business organization to pay its obligations and their interests at the appropriate time.
2. Government
Financial information is important for tax purposes and in checking of compliance with
Securities and Exchange Commission (SEC) requirements.

3. Potential Investors/ Creditors

Before making an investment or extending credit, potential investors or creditors may not only
be interested in the company's current financial position and results of operations, but also in the
company's financial history. This should give them the assurance that their investment will yield a
reasonable rate of return or the credit extended will be paid within a reasonable period of time.
FORMS OF BUSINESS ORGANIZATIONS
1. Sole/ Single Proprietoreship - owned and managed by only one person
- must be registered in DTI
2. Partnership - Article 1767 (Partnership Law) “By the contract of partner-
ship, two or more persons bind themselves to contribute
money, property, or industry to a common fund with the
intension of dividing the profit among themselves.
- Must be registered in SEC (Securities and Exchange Commission)
3. Corporation - Batas Pambansa #68/ 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.
- must be registered in SEC (Securities and Exchange Commission)
4. Cooperatives - Section 3 of R.A 6938 “A cooperative is a duly registered
association of persons, with a common bond of interest, who have
voluntarily joined together to achieve a lawful common social or
economic end, making equitable contributions to the capital
required and accepting a fair share of the risks and benefits
of the undertaking in accordance with universally accepted
cooperative principles.”
- must be registered in CDA (Cooperative Development Authority)

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FORMS OF BUSINESS ORGANIZATIONS

1. Service - engaged in rendering services
2. Trading/ Merchandising - engaged in buying and selling of goods
3. Manufacturing - engaged in the production of items to be sold
 ACCOUNTING CONCEPTS AND PRINCIPLES

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

 Encompasses the conventions, rules, and procedures necessary to define accepted accounting practice at
a particular time
 These principles provide the general framework for determining what information is included in the
financial statements and how this information is to be prepared and presented
 These accounting principles, standards, and procedures issued by the Financial Accounting Standards
Board (FASB)
 As applied in the Philippines:
 A. Philippine financial reporting standards (PFRS)
-- adopted from the IFRS (International Financial Reporting Standards)
 B. Philippine accounting standards (PAS)
-- adopted from the IAS (International Accounting Standards)

THE STANDARD SETTING PROCESS IN THE PHILIPPINES

Before 1981, the Philippines did not have a formal process for the development of accounting
practices, it was only in late 1981, when the Philippine Institute Of Certified Public Accountants (PICPA)
organized the Accounting Standards Council that formalized the standards setting process in the
Philippines.

ACCOUNTING STANDARDS COUNCIL (ASC)

 It was formed on November 18,1981 - to study the standard setting process in the Philippines
 The ASC was composed of 8 members, representing the following organizations :
1. PICPA - Philippine Institute Of Certified Public Accountants
2. SEC - Securities and Exchange Commission
3. BSP - Bangko Sentral ng Pilipinas
4. BOA - Board of Accountancy
 FUNDAMENTAL CONCEPTS/UNDERLYING ASSUMPTIONS

1. ACCOUNTING ENTITY CONCEPT

 “ The business is treated as a person separate and distinct from the owner or investor”
 It is also known as the “economic entity assumption or business entity concept”
 The personal transactions of the owner are separate from that of the business he/she owns.

2. PERIODICITY ASSUMPTION
 “It refers to the time span when the accountant has to prepare the Financial Statements”
 Also known as “ Time Period Assumption”
 It means that the economic activities of an accounting entity are divided into various artificial time
periods for financial reporting purposes.
 General Rule: 1 year= 1 accounting period/cycle
Example: Separate financial reports are prepared yearly for the skin clinic and the spa of Dr. Teng. Hence,
Dr. Teng can measure the income of the two businesses annually.

3 CLASSIFICATION OF ACCOUNTING PERIODS

 Calendar Year - 12-month period that starts on January 1 and ends on December 31.
 Fiscal Year - 12 month period that starts on any month of the year other than January and ends
twelve months after the starting period.
 Natural Business Year - is any twelve month period that ends when business activities are
their lowest point (lean/slack season)

3. GOING CONCERN ASSUMPTION

 “The business is continuing concern or that it has an indefinite existence”
 It is also known as “ continuity assumption”
 Businesses are established with the intention that the business will survive and continue indefinitely,
and that company closure is not imminent.
Example: In preparing the financial statements of the skin clinic and the spa, the accountant assumes that the
business will not close or shut operations within the next years.
 BASIC ACCOUNTING PRINCIPLES

1. OBJECTIVITY PRINCIPLE
 States that all business transactions that will entered In the accounting records must be duly supported by
verifiable evidence (O.R., S.I., C.I, etc.)
Example: Payments must be supported by official receipts and bank deposits must be supported by deposit
slips.

2. HISTORICAL COST
 That all properties and services acquired by the business must be recorded at their original acquisition cost.
Example: Land bought in 2001 for two million pesos should be recorded at two million pesos even though its
market value in the year 2016 is already three million pesos.

3. ACCRUAL BASIS OF ACCOUNTING

 “ Revenue or income is recognized when earned such as when goods are delivered or when services have
been rendered, regardless of collection. Expenses are recognized when incurred regardless of payment”
 The term “total expenses” is not the same with “total cash payments”, and the term “total income” is
different from “total cash receipts”

4. ADEQUATE DISCLOSURE
 That the accountant should include all of the sufficient information needed so that the readers of the
financial statements will have informed judgement.
Example: Land bought at two million pesos in 2001 should be recorded at historical cost in the 2016 financial
statements. However, the current market value of three million pesos in the year 2016 may be indicated in the
financial statements for the year 2016 in the form of a footnote or parenthetical note.

5. MATERIALITY
 means that financial reporting is only concerned with information significant enough to affect decisions.
This refers to the relative importance of an item or event. An item is considered significant if knowledge of
it would influence prudent users of the financial statements.
 In accounting, materiality refers to the impact of an omission or misstatement of information in a
company’s financial statements on the user of those statements. If it is probable that users of financial
statements would have altered their actions if the information had not been omitted or misstated, then the
item is considered to be material.
 The concepts of materiality is usually used in audit not in accounting.
Example: Items of insignificant amount such as paper clips can be charged outright to expenses.
6. CONSISTENCY
 Means that approaches used in reporting must be uniformly employed from period to period to allow
comparison of results between time periods. Any changes must be clearly explained.
Example: If the straight line method of depreciation is being used by the company, then the method should be
uniformly used by the company in computing its annual depreciation.

7. MONETARY UNIT PRINCIPLE

 Means that money is used as a unit measurement and only business transactions that has monetary value are
recorded using a single currency.
 “ all business transactions are recorded & expressed in peso amounts”
 It is also known as “measurement in terms of money assumption”
Example: A machine imported from the United States is recorded in Philippine peso although purchased in
dollars. The dollar exchange rate was used to convert the cost of the machine from dollars to peso.

8. MATCHING PRINCIPLE
 Means that expenses are matched to the income earned during the period.
Example: Gasoline expense is charged to the period when the service was rendered or the goods delivered.

9. CONSERVATISM PRINCIPLE
 Means that in situations where there are two possibilities, choose the one that will have the least favorable
effect on the financial statements. This principle is also called Prudence.
Example: Bad debts expense is recognized as possible losses due to the uncollectability of certain accounts
receivables