I.

INTRODUCTION TO ACCOUNTING
By the end of the study, the student should be able to:
1. Define accounting;
2. Describe the nature of accounting;
3. Explain the functions of accounting in business;
4. Define internal users of accounting data and give examples;
5. Define external users of accounting data and give examples;
6. Narrate the history or origin of accounting; and
7. Cite examples in which accounting is used in making business
decisions.

Need for Accounting.

Human beings have limitations. Everyday transactions cannot be retained
in the human brain for quite a period of time without confusions and
complications. To avoid these, transactions and other important events should be
recorded. Such written records serve as reference for future recall.
In business, several parties are interested to its records to seek answers to
their questions and bases for their decisions. These parties can be classified into
direct users or those who have direct interest to business records an indirect
users or those who are indirectly interested to the accounting information of the
business. Among the direct users are the following:

1. Owner.
Questions like “Has the business improved?” Is it wise to make additional
investments? Is there a need for it?” may be asked by the owner of a firm. He is
interested to know whether the business should be maintained, increased,
decreased, or disposed of completely. Further, he is interested to know whether
he is getting a fair return of his investment.

2. Management.
The management may ask questions such as “What are the resources of
the business? How much is its debts? What are the expenses which can be
minimized? Did the business earn? What is the proportion of the expenses to
sale? Is there a need for expansion?”
To the management, financial information serves as a measure for making
future financial decisions and a measure of its effectiveness.

3. Prospective Investors.
“Will my money grow in this business?” an investor may ask. An investor
is interested in the financial statement to determine whether to acquire ownership
in the firm.
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4. Creditors.
A creditor may ask the following questions before granting loans: “Can the
business meet its obligations?” Creditors use financial statements as a basis to
answer such question.

5. Employees.
“Are we receiving fair remuneration?” or “Can we ask for more financial
assistance/benefits?” are some questions which an employee may ask.
Employees are interested in information to enable them to assess the ability of
the firm to provide remuneration and other benefits.

6. Government.
“Is this the firm reporting the correct amount of income?” may be one of
the questions asked by the government particularly the Bureau of Internal
Revenue. The government needs accounting information to regulate the firm’s
activities and determine the basis for taxation policies.

All of these questions and many others can be answered and wise
decisions can be made only after a thorough study of the accounting reports of
the business. Likewise, to the employees and labor unions such information is
useful for negotiating raise in wages and conducive working conditions; and to
the government, accounting records are needed to regulate businesses and for
tax collection purposes.

Activity 1.
1. Who are the external users of accounting information? Explain the specific
needs of each type of external users.
2. In your own point of view, which external user benefits the most form of
accounting information? Explain.
3. How can the operations of a company affect the general public? Is the effect
on the general public direct or indirect? Explain.

Why study accounting?

In order to appreciate and understand the financial reports of the business,
one should have an understanding of how data are gathered and recorded.
All these understandings are gained in the study of accounting.
Accounting can also be one’s profession – a work which is interesting and highly
rewarding.

Definition of Accounting.
The Committee on Terminology, American Institute of Accountants defined
accounting as “the art of recording, classifying, 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.”
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Accounting is an art. It is the language of the business. Through the

accounting data prepared, the business communicates to the different interested
parties the results of its operation and its financial condition.
Aside from this, the accountant’s opinion and estimation are needed in
preparing accounting data and reports. Accounting, however, is not only an art
but also a science in a way that there are accounting principles that serve as a
guide in accomplishing data and preparing reports.

Four phases of Accounting.

Based on the definition, accounting has four phases namely: recording,
classifying, summarizing and interpreting.

Recording.
This is technically called bookkeeping. Some people confuse bookkeeping
and accounting as one and the same. However, bookkeeping is only a part of
accounting – the recording phase. In this phase, business transactions are
recorded systematically and chronologically in the proper accounting books.
There are two kinds of bookkeeping: the single entry bookkeeping and the
double entry bookkeeping.
Single entry bookkeeping does not show the two-fold effects of business
transactions. It shows only the debit or the credit of each transaction.
The double entry bookkeeping, however, reflects the two-fold effects of
business transactions. It has a debit and a credit. In this book the double entry
bookkeeping will be dealt.

Classifying.
In this phase, items are sorted and grouped. Similar items are classified
under the same name. They may be classified as (1) Asset accounts, (2) Liability
accounts, (3) Capital accounts, (4) Revenue accounts and (5) Expense accounts.

Summarizing.
After each accounting period, data recorded are summarized through
financial statements. These reports are submitted to the management at the end
of each accounting period or as the need arises.

Interpreting.
Usually, due to the technicality of accounting reports, the accountant’s
interpretation on the financial statement is needed. In this case, analysis reports
are submitted together with the financial statements.

Nature of Accounting.
The five basic features of accounting are as follows:
1. Accounting is a process.
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A process is composed of multiple steps that lead to a common end goal.

The enrollment process in your school may involve reservation of slots, filling out
documents, attending school orientations, and payment of necessary fees. These
steps all lead to you being enrolled in your school. Likewise, accounting is a
process because it performs the functions of identifying, recording, and
communicating economic events with the end goal of providing information to
internal and external parties.

2. Accounting is an art.
Art refers to a way of performing something. It entails creativity and skills
to help us attain some objectives. Accounting is the art of recording, classifying,
summarizing, and finalizing financial data. Accounting is a combination of
techniques and its application requires applied skill and expertise. This is the
reason why accounting can be considered as an art.

3. Accounting deals with the financial information and transactions.

Accounting deals only with quantifiable financial transactions. These are
the only events identified by the accountant, recorded in the books, and
communicated to different parties. Non-financial transactions are not the focus of
the accounting process. However, non-financial data may be used to interpret
and better estimate some financial data.

4. Accounting is a means not an end.

Accounting is a tool to achieve specific objectives. It is not the objective
itself. Imagine that you dream to go to Paris someday. Accounting can be thought
as the plane that will bring you to your destination.

5. Accounting is an information system.

Accounting is recognized and characterized as a storehouse information.
As a service function, it collects processes and communicates financial
information of any entity. This discipline of knowledge has been evolved out to
meet the need of financial information required by different interested groups.

Activity 2.
1. Define accounting.
2. State the four phases of accounting. Explain each
3. What is the nature of accounting?

Functions of Accounting.
1. Keeping systematic record of business transactions.
2. Protecting properties of the business.
3. Communicating results to various parties in or connected with the
business.
4. Meeting legal requirements.
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Activity 3.
1. Do you agree: “Accounting is vital to the success of a business?” Explain.
2. Give five examples in which accounting is used in making decisions.
Explain the role accounting plays in these decision.
3. Give a concrete example on how you can use accounting in your daily life.

Business Organizations.
Business organizations can be classified into two:
(1) according to ownership; and
(2) according to the nature of the business.

A. Ownership.
1. Single or Sole proprietorship.
a. Sole proprietorships, as the name suggests, are business formed by a
single individual.
b. Sole proprietorship is considered the simplest form under which a
business can operate.
c. Businesses operating as sole proprietorships do not have separate legal
existence from the owner.
d. The law does not recognize a sole proprietorship as a separate juridical
entity distinct from the owner.
e. Owners can opt to operate the business under their own names or use
fictitious names such as Aling Nene Sari-Sari Store.

Advantages of a Sole proprietorship:

a. Ease of Formation.
b. The owner has full control of the business.
c. Owners can mix personal and business assets.
d. Owners have all the profits for themselves.
e. Simple taxation.
Disadvantages of a Sole proprietorship.
a. Unlimited liability.
b. Difficulty of raising additional capital
c. Owner’s bias. Having more minds to think of ideas on how to improve
business or how to solve problems encountered by the business is better than
one having the sole authority to make decisions.

Activity 4.
1. What is a sole proprietorship?
2. What are the advantages of a sole proprietorship?
3. What the disadvantages of a sole proprietorship?
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4. Based on your understanding of the topic, what types of businesses are most
likely organized as a sole proprietorship?
2. Partnership.
According to the Partnership Code of the Philippines, Title IX of the Civil
Code of the Philippines, a partnership is a contract whereby two or more persons
bind themselves to contribute money, property, or industry to a common fund,
with the intention of dividing the profits among themselves. Two or more persons
may also form a partnership for the exercise of a profession.

General features of partnership:

a. Separate legal existence. (Juridical personality)
b. Mutual agency. The acts of the partners are binding on a partnership
even though he or she has no authority to do so as long as the act concerns the
normal business operations of the partnership. (the act must be related to the
operation of the business.)
c. Unlimited liability.
d. Limited life. (dissolution or liquidation)
e. Co-ownership of partnership property.
f. Partnership agreement. Partnership is a contract covered by the Articles
of Partnership, and it contains the following information:
i. Name of the partnership
ii. Location of the principal office of the Partnership.
iii. The names, citizenship, and residence of the partners.
iv. Term for which the partnership is to exist.
v. The purpose for which the partnership is formed.
vi. Original capital contribution of the partners.
vii. Profit and loss sharing agreement among the partners.

Activity 5.
1. What is a partnership?
2. What are the general features of a partnership?
3. Explain the advantages and disadvantages of a partnership.
4. What are articles of a partnership? What is its purpose?

3. Corporation.
Our law defines a corporation as “an artificial being created by operation of
law, having the right of succession and attributes, and properties expressly
authorized by law or incident to its existence.”

The definition emphasizes four things:

a. A corporation is an artificial being. It means that it is an entity separate
and distinct from its owners.
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b. A corporation is created by operation of law. Individual cannot form a

corporation by themselves. The law must play a role in the formation of a
corporation.
c. A corporation has the right of succession. Ownership rights can be
passed to other persons through sale, donation, or any other mode of transfer.
d. The law is the source of the powers and attributes of a corporation.
Being the source, the law can likewise restrict the authority of corporations in
performing acts.

General Features of a corporation.

1. Separate legal existence.
2. Limited liability.
3. Transferable ownership rights
4. Virtually unlimited life.
5. Corporation management
6. Government regulations.
7. Double taxation.
8. Dividends.

Advantages and Disadvantages of a Corporation.

Advantages Disadvantages
1. Ability to acquire additional capital. 1. Heavily regulated by the government.
2. Transferable ownership rights 2. Double taxation.
3. Limited liability of stockholders 3. Not easy to form.
4. Virtually unlimited life 4. More expensive to form than sole
5. Large pool of human capital proprietorships and partnership.

Activity 6.
1. What is a corporation? Explain the general features of a corporation.
2. What are the advantages and disadvantages of a corporation compared to
partnerships and sole proprietorships?
3. Illustrate and explain the general structure of the management of a
corporation.

B. Nature of Business.
A business is an organization that converts inputs or resources such as
material, labor and overhead into inputs which are usually either goods or
services. There are three major types of business as follows:

1. Service Companies.
Service companies are firms that generally use their employees to provide
intangible products or services to customers. These services include
professional skills, advice, expertise, and other related customers. The primary
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source of revenues of service companies is the performance of services, often

referred to as service revenues.

a. Law firm e. Accounting firms

b. Hospital f . Bus company
c. Hotels, Restaurants, SPA, etc g. Banks
d. School
Operating Cycle of Service Companies

Cash on
Hand

Pays
Receives employees
payment and other
from expenses
customers

Performs
services

2. Trading or Merchandising companies.

Merchandising companies sell tangible products. This type of business
buys finished or almost finished goods from their suppliers and resells the same
to customers. Merchandising companies primarily earn revenues from the sale of
the goods or merchandise, also known as sales revenue or sales.

There are two types of merchandising companies:

a. Retailer
b. Wholesaler

Operating Cycle of Merchandising Companies

Cash on
Hand

Receives
payment Buys
from Goods
customers
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Stores
3. Manufacturing Companies.
Sells
inventoryor simply goods as
Manufacturing companies, manufacturers, are relatively
inventory
complicated organizations than service and merchandising companies. As the
name suggests, manufacturers create their own products. They use raw
materials, components, or parts which are processed using machines,
computers, and labor to produce finished goods.
Since a manufacturing company produces its own products, its operating
cycle generally has the longest period compared to service and merchandising.
The cycle has an additional phase which is the production of goods. These goods
are also held as inventory and later sold to its customers. Likewise, the operating
cycle of a manufacturing company ends with the collection of cash payment.

Cash on
Hand
Receives Pays for
payment inputs,
from (materials,
customers labor,
overhead)

Converts
Sells inputs into
Inventory finished
goods
Stores
finished
goods as
inventory

Operating cycle of Manufacturing Companies

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Type of
Business Definition Input Output Examples
According to
activities
Firms that generally use Accounting
Service their employees to Labor Intangible: and law firms,
provide services to Service hospitals,
customers schools,
salons
Firms that buy finished Supermarkets,
or almost finished goods Goods or Tangible: convenience
Merchandising from their suppliers and merchandise Merchandise stores,
resell the same to bought from bookstores,
customers. suppliers department
stores
Tangible: Car companies,
Firms that create their Raw materials, Manufactured consumer
Manufacturing own products. labor, overhead products products,
electronic
companies,
energy
manufacturers

History of Accounting.
It is believed that the history of accounting is thousands of years old and
can even be traced to ancient civilizations. A number of history books suggest
that the early development of accounting can be dated back to ancient
Mesopotamia. During those times, people followed a system of writing and
counting money. The development of accounting may be related to the taxation
and trading activities of temples.
The reign of Emperor Augustus (63BC – 14AD) provided more evidence
about the development of accounting. The Roman government kept detailed
financial information of the deeds of Emperor Augustus regarding the
stewardship of Roman resources. This is evidenced by the Res Gestae Divi
Augusti (The Deedss of the Divine Augustus). The Roman historians Suetonius
and Cassius Dio recorded that in 23 BC, Augustus prepared a rationarium
(account) which listed public revenues, the amounts of cash in the aerarium
(treasury), in the provincial fisci (tax officials), and in the hands of the publican
(public contractors); and that it included the names of the freedmen and slaves
from whom a detailed account could be obtained. The closeness of this
information to the executive authority of the emperor is attested by Tacitus’
statement that it was written out by Augustus himself. (Oldroyd 1995)
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Many consider the dissemination of the double-entry bookkeeping of Luca

Pacioli in the fourteenth century Italy is the most important event in accounting
history. In fact, Luca Pacioli is acknowledged as the father of modern accounting
because of this. The double-entry bookkeeping system is defined as any
bookkeeping system that has a debit and a credit for each transaction. Luca
Pacioli’s Summa de Arithmetica, Geometria, Proportionalita (Review of
Arithmetic, Geoemetry, Ratio, and Proportion) is the first book printed with a
treatise on bookkeeping. The double-entry bookkeeping system is the system
being used to this very day. (Sangter et al. 2007)
The modern profession of the chartered accountant originated in Scotland
in the nineteenth century when Queen Victoria granted a royal charter to the
Institute of Accountants in Glasgow. At present times, accounting standards are
already available to guide accountants in their practice of the profession. Some of
the these standards include the PFRS (Philippine Financial Reporting Standard)
and the PAS (Philippine Accounting Standards).