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Module in Financial Accounting and Reporting 1 semester 2021-2022

Module 1 INTRODUCTION TO ACCOUNTING AND BUSINESS, ACCOUNTING CONCEPTS

AND PRINCIPLES

Learning Objectives:

1. Explain what Accounting is

2. Identify the users and Uses of Accounting
3. Understand why ethics is a fundamental business concept.
4. Explain generally accepted accounting principles
5. Explain the monetary unit assumption and the economic entity assumption
6. State the accounting and define its components
7. Analyze the effects of business transactions on the accounting equation

What is accounting?

Accounting is an information system that identifies, records, and communicates the economic
events of an organization to interested users.

Accounting is the art of recording, classifying, and summarizing in a significant manner and in
terms of money, transactions, and events, which are at least in part of a financial character, and
interpreting the results thereof. This is according to 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, intended to be useful in making economic
decisions. This is according to the Accounting Standards Council

Accounting is the process of identifying, measuring, and communicating economic information

to permit informed judgment and decisions by users of the information. This according to the
American Accounting Association (AAA).

Based on the definitions above, there are unifying themes that describe the nature of
Accounting (Rabo, Tugas, and Salendrez, 2016)

 Accounting deals with transactions that are financial in nature. The definition of ASC
requires that business transactions have to be measured in terms of money. All other
transactions that are non-monetary are not within the scope of Accounting

 Accounting is an art. The word „art‟ refers to the desing of how something can be
performed. It is a behavioral knowledge involving creativity and skill. By the very nature
that accounting activity is systematic, it has definite techniques and its proper application
requires a particular skill and expertise.

 It is a systematic series of the actions directed towards a particular outcome. As a

process, Accounting performs specific actions such as identifying, measuring, and
communicating financial information. It has to follow logical steps in the accounting
cycle like recording, classifying, and summarizing financial transactions, and
communicating the results thereof.

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 Accounting is also an “information system‟. This is a set of interrelated components that

work together to achieve a common purpose. It also serve as a repository of collected
financial data, proposed financial information, and communicated financial statements.

 Moreover, accounting is a means and not an end. Although this has a tangible output,
in the form of financial statements, it still underscores that users have the liberty to make
economic decisions based on the management assertions in the financial statements.
Using this logic, accounting indeed paves the way to an end and it is not the end itself.

Three activites of Accounting

1. Identifies the economic events relevant to its business. The first part of the process,
identifying, involves selecting those events that are considered evidence of economic
activity relevant to a particular business organization.
2. Record those events relevant to its business. Recording is the keeping of a
chronological diary of events, measured in dollars and cents
3. Communicate the collected information to interesed users by means of accounting
reports. Communication occurs through the preparation and distribution of accounting
reports.

THE FUNCTION OF ACCOUNTING:

 To support daily operations of the business

 To help interested users come up with informed decisions
 To fulfil the stewardship function of the owner/management

Who uses accounting Data

The financial information that users need depends upon the kinds of decisions they make.
There are two broad gorups of users of financial information: internal users and external users.

Internal Users

Internal users of accounting information are managers who plan, organize, and run the
business. These include marketing managers, production supervisors, finance directors, and
company officers.

External Users

External Users are individual and organizations outside a company who want financial
information about the company.The two most common types of external users are investors and
creditors. Investors (owners) use accounting information to decide whether to buy, hold, or sell
ownership shares of a company. Creditors (such as suppliers and bankers) use accounting
unformation to evaluate the risks of granting credit or lending money.

External Users are those who make their decisions based on the company‟s financial
information.
 Investors – Financial information will help them decide whether they should invest or not
in the business.
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 Creditors – They asses credit worthiness and the capability of the business to pay its
obligation including the related interest on maturity date.

 Customers – They have interest in information about the continuance of an enterprise,

especially when they have a long-term involvement with, or are dependent on, the
enterprise.

 Employees – Assess the company‟s profitability and stability, its consequence on their
future salary and job security.

 Suppliers – They use the financial information to determine whether the debts owed to
them will be paid when due or whether the customer has enough funds or resources to
pay the goods to be delivered or the services to be rendered.

 Tax Authorities – Determines the credibility of the tax returns filed on behalf of the
company. They are interested to know if the business paid the correct amount of taxes.
 Government and Regulatory Bodies – Ensures that the company‟s disclose of
accounting information is in accordance with the rules and regulations set in order to
protect the interest of the stakeholders who rely on such information.
 Public – They use the financial information to know the trends and recent developments
in the prosperity of the enterprise and the range of its activities.

Branches of Accounting

Areas of Accounting are

 Financial Accounting – the gathering, classifying, analysing, revording fo financial data in

the books of accounts, and the preparation of reports to management on the financial
data. It involves bookkeeping- the procedural aspect of recording financial data and
preparing of reports

 Management Accounting – has no precise coverage but it is used generally to refer to

services to clients on matter of accounting, finance, business policies, organization
procedures, product costs, distribution and many other phases of business conduct and
operations.

 Auditing

 Internal Auditing – Review the business operations to check if they comply to

management policies. It also evaluates the efficiency of business operations.
Normally, an internal auditor is a hired employee of a company (Rabo, Tugas &
Salendrez, 2016).
 External Auditing – The work of Certified Public Accountants (CPA) outside the
business organization, in ascertaining the correctness of data in the financial

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statements, for the statements‟ acceptability to the public and to government

regulatory agencies (Reyes, 2016).

 Tax Accounting – Deals with the preparation of various tax returns and doing tax
planning for the business. The data prepared is to be reported to the revenue collection
agencies of the government (e.g Bureau of Internal Revenue) (Rabo, Tugas, &
Salendrez, 2016).

 Government Accounting – Used by all branches of the government and by those who
receive government funds to oversee the complicated business of providing government
services or to report to the government on the use of government funding in compliance
with the imposed regulations (Cabrera, 2016)

 Cost Accounting – Analyses the costs incurred by the costs incurred by the business to
help managers control expenses. Good cost accounting records guide managers in
pricing their products and services to achieve greater profits. Also, cost accounting
information shows management when a product is not profitable and should be dropped
(Cabrera, 2016).

 Accounting Education – Responsible for training future accountants. It engages in

teaching accounting, financial management, taxation, and other related business course.
Per CHED Memorandum Order (CMO) No. 3, Series 2007, a CPA in accounting
education should possess the educational qualifications, professional experience,
classroom teaching ability, computer literacy, scholarly research productivity, and other
attributes that are essential for the successful conduct of a professional accounting
program. CPAs are encouraged to be part of the academe and become an integral force
in inspiring students to pursue a career in accounting. Accounting educators could be
professors, deans, or researchers (Rabo, Tugas, & Salendrez, 2016).

 Accounting Research – Plays an essential part in creating new knowledge. The hard
sciences have produced models of research and testing than can be used and applied
over many disciplines including accounting research. Using these models along with
evidence such as financial statements, stock prices, surveys, experiments, computer
simulations, and mathematical proofs, we can gain a scientific perspective and basis for:
(1) deciding and implementing new accounting or auditing standards; (2) presenting
unusual economic transactions in the financial statements; (3) learning how new tax
laws impact clients and employers; and (4) discerning how the accounting profession
affects the capital markets through academic accounting research (Bringham Young
University, 2015).

Forms of Business Organization

1. Proprietorship

A business owned by one person is generally a proprietorship. The owner is often

the manager/operator of the business. Small service type of business, and small retail stores
are often proprietorship. Usually, only a relatively small amount of money (capital) is necessary
to start in business as a proprietorship. The owner (proprietor) receives any profits, suffers any

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losses, and is personally liable for all debts of the business. There is no legal distinction
between the business as an economic unit and the owner; but the accounting records of the
business activities are kept separate from the personal records and activities of the owner.

2. Partnership

A business owned by two or more persons associated as partner is a partnership.

In most respects a partnership is like a proprietorship except that more than one owner is
involved. Typically, partnership agreement (written or oral) sets forth such terms as initial
investment, duties of each partner; division of net income (or net loss), and settlement to be
made upon death or withdrawal of a partner; Each partner generally has unlimited personal
liability for the debts of the partnership. Like a proprietorship, for accounting purposes the
partnership transactions must be kept separate from the personal activities of the partners.
Partnerships are often used to organize retail and service-type business, including professional
practices.

3. Corporation

A business organized as a separate legal entity under state corporation law and
having ownership divided into transferable shares of stock is a corporation. The holder of the
shares (stockholders) enjoys limited liability; that is, they are not personally liable for the debts
of the corporate entity. Stockholders may transfer all or part of their ownership shares to other
investors at any time (i.e., sell their shares).

Comparison of the Forms of Business Organization

SOLE PARTNERSHIP CORPORATIO COOPERATIV
PROPRIETORSHI N E
P
Ownership One (1) owner Two (2) or more Five (5) or more At least 15
Capitalization Depends on the Depends on the Depends on the Depends on
needs of the needs of the type of business the type of
business business as prescribed business as
by law prescribed by
its by-laws
which contain
rules and
regulations
governing the
operation of
cooperative.
Management Managed by the Managed by one (1) Managed by the Managed by
Structure sole proprietor or more partners board of the board of
directors directors.
Business 1. Register the 1. Verify business 1. Verify 1. Prepare a
Requirements preferred business name with SEC. business name general
name with the 2. File articles of co- with SEC. statement also
Department of partnership with 2. Draft and called an

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Trade and Industry SEC. execute the economic

(DTI). Renewable 3. Register the articles of survey to help
every five (5) business name with incorporation by measure the
years. DTI. incorporators. cooperative‟s
2. Secure a 4. Secure a 3. Deposit the chance of
barangay permit in barangay permit in cash collected success.
the place business the place business from 2. Draft
is located. is located. 5. subscription. cooperative‟s
Renewable yearly. Register the 4. File articles by-laws.
3. Apply business business with BIR. of incorporation 3. Draft the
permit in the (annual registration with SEC. articles of
municipality where fee) 5. Register the corporation.
the business is 6. Register the business name 4. Secure bond
located. business with SSS, with DTI. for accountable
Renewable yearly. PhilHealth, and 6. Secure a officer(s). The
4. Register the HDMF or Pag-ibig. barangay permit accountable
business with the in the place officers
Bureau of Internal business is normally are
Revenue (BIR) located. the Treasurer
(annual registration 7. Apply and the
fee) business permit Manager. The
5. Register the in the amount of the
business with municipality bond is to be
Social Security where the decided upon
System (SSS), business is by the Board of
Philippine Health located. Directors,
Insurance 8. Register the based on the
corporation business with initial net worth
(PhilHealth), and the BIR (annual of the
Home registration fee). cooperative
Development 9. Register the which includes
Mutual Fund business with the paid-up
(HMDF) or Pag- SSS, capital,
ibig. PhilHealth, and membership
HDMF. fees and other
assets of the
cooperative at
the time of
registration.
5. Registration
with
Cooperative
Development
Authority
(CDA).
Advantages 1. Easy to form, 1. Increased 1. More source 1. Unlimited
easy to dissolve. potentials from two of funds. life. The
2. Full control of (2) or more different 2. Easy to change of
operations. strengths. transfer members does
3. All profits go 2. Easy to form with ownership. not dissolve the
directly to the proper agreements 3. Limited business.

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owner. on its formation. liability. 2. Democratic

4. Less regulations. 3. Less regulations 4. Unlimited organization.
5. The government compared to commercial life. Social equality
taxes the owner corporations. of members is
not the business. 4. Professional the most
partnership is tax- important
exempt. component of
cooperatives. It
ensures that it
serves its
members‟
needs.
Disadvantage 1. Unlimited liability 1. Unlimited liability 1. More 1. Obtaining
s – the owner is of all partners. regulations to capital through
legally obliged to 2. Limited life- be followed. investors.
pay all business admission of a new 2. Profit is taxed Cooperative
debts. partner or the by the corporate has a “one-
2. Limited life – the retirement/withdraw tax rate. member-one-
business ceases to al of a partner 3. Costly to vote”
operate if the dissolves the incorporate. philosophy. Big
owner dies, partnership. investors may
becomes insane, 3. High possibility of choose to
or imprisoned. dispute and conflicts invest their
3. Difficulty in between partners. money to other
raising capital. firms where
their voting
power is equal
to their
ownership
interest.
2. Lack of
membership
and
participation.
The
cooperative
may not fully
function if
members do
not involve
themselves in
the routine
business
operation.

Types of Business According to Activities

 Merchandising Business – Commonly known as the “buy and sell” business. Products
are bought from manufacturers or other merchandisers and are sold as is at an amount
higher than the purchase price. Examples are grocery stores, hardware, department
stores, and drug stores (Rabo, Tugas, & Salendrez, 2016.)

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 Manufacturing Business – The process of converting raw materials into finished

products. The manufacturer buys the raw materials, applies direct labor and factory
overhead to create finished products (Frias, 2016). Examples are food factories,
garment factories, and car manufacturing companies.

 Service Business – Focuses on providing intangible products such as offering

professional skills, proposal, and expertise. Examples are accounting firms, law firms,
schools, medical clinics, banks, hair salons and spas, and repair shops.

Comparison of the Types of Business

MERCHANDISING MANUFACTURING SERVICE
Activity Buys goods and sells Converts raw Does work for others
in the same form materials to finished
goods
Nature of Revenue Sales Sales Service Income
Cost and Expenses Cost of Goods Sold Cost of Goods Sold Service Income
Selling & and Manufactured Cost of Service and
Administrative Selling & Administrative
Expenses Administrative Expenses
Expenses
Forms of Business Sole Proprietorship/Partnership/Corporation/Cooperative
Advantages 1. Good 1. There is a 1. No need for
merchandising continuous demand inventory.
attracts more on manufactured 2. Skills can be
customers. goods. improved and can
2. It is flexible to 2. Job satisfaction can produce better
changes. be ensured through service.
the output or the
produced item.
Disadvantages 1. It demands more 1. Owners need to 1. Services are harder
work and workers. keep up with the high to value.
2. It needs to manage overhead costs. 2. Less demand
customer‟s 2. The cost of the during economic
expectations. manufactured downturns.
3. It needs to budget products highly
expenses for depends on the price
occasional and availability of the
improvements within raw materials.
the store.

The Building Blocks of Accounting

Ethics in Financial Reporting

The standard of conduct by which actions are judged as right or wrong, honest or dishonest, fair
or not fair, are ethics. Effective financial reporting depends on sound ethical behavior.

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Generally Accepted Accounting Principles

The accounting profession has developed standards that are generally accepted and universally
practiced. This common set of standards is called generally accepted accounting principles
(GAAP). These standards indicate how to report economic events.

Measurement Principles

GAAP generally uses one of two measurement principles, the historical cost principle or the fair
value principle. Selection of which principle to follow generally relates to trade-offs between
relevance and faithful representation. Relevance means that financial information is capable of
making a difference in a decision. Faithful representation means that the numbers and
descriptions match what really existed or happened- they are factual.

Historical Cost Principle

The historical cost principle (or cost principle) dictates that companies record assets at
their cost. This is true not only at the time the asset is purchased, but also over the time the
asset is held.

Fair Value Principle

The fair value principle states that assets and liabilities should be reported at fair value
(the price received to sell an asset or settle a liability). Fair value information may be more
useful than historical cost for certain types of assets and liabilities.

Assumptions

Assumptions provide a foundation for the accounting process. Two main assumptions are the
monetary unit assumption and the economic entity assumption.

Monetary Unit Assumption

The monetary unit assumption requires that companies include in the accounting records
only transaction data that can be expressed in money terms. This assumption enables
accounting to quantify (measure) economic events. The monetary unit assumption is vital to
applying the historical cost principle. This assumption prevents the inclusion of some relevant
information in the accounting records.

Economic Entity Assumption

An economic entity can be any organization or unit in society. It may be a company, a

government unit, a municipality, a school district, or a church. The economic entity assumption
requires that the activities of the entity be kept separate and distinct from the activities of its
owner and all other economic entities. This was discussed above in the forms of business
organization.

The Accounting Equation

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The basic accounting equation is:

Assets = Liabilities + Owner's Equity.

The accounting equation applies to all economic entities regardless of size, nature of business,
or form of business organization.

The key components of the basic accounting equation are:

a. Assets are resources controlled (not necessarily owned) by a business that are
necessary for the conduct of its activities.
b. Liabilities are claims against assets. These represent obligations that are owed to
third parties in the form of loans, payables, etc.
c. Owner's equity is the residual claims of owners against the assets. This represents
the remaining portion of the business that is retained by the owner after the assets
are used to settle the liabilities.

To understand this a little better, let‟s consider that you want to create your own business, i.e. a
computer shop. In order to start the business, you would need cash, a couple of computer units,
chairs, internet connection, business space, and other necessary equipment. These resources
are the ASSETS of your business.

If you personally have the needed assets for your business, then you can right away invest
those assets into the business enterprise. By investing into the business, you, as the owner now
has a claim over the assets of the business. This claim is the OWNER‟S EQUITY.

IF you don‟t personally have the needed assets, then you can borrow money from a bank to buy
the assets. The act of borrowing creates an obligation to a third party, that is the obligation to
pay back the money owed. This obligation is the LIABILITY.

So, in order to have assets in your business, you could either OWN (owner‟s equity) them
already, or you could BORROW (liabilities) from other parties.

To summarize, look at the accounting equation again:

Assets = Liabilities + Owner's Equity.

RESOURCES Borrowed Owned

SOURCES of the RESOURCES

In proprietorships, there are four subdivisions of owner's equity:

a. Investments by Owner / Capital are the assets put in the business by the owner.
b. Revenues are the gross increases in owner's equity resulting from business activities
entered into for the purpose of earning income.
c. Drawings are withdrawals of cash or other assets by the owner for personal use.
d. Expenses are the cost of assets consumed or services used in the process of
earning revenue.

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An expanded form of the accounting equation can be expressed as:

ASSETS = LIABILITIES + OWNER'S CAPITAL - OWNER'S DRAWING + REVENUES –

EXPENSES

Revenues and expenses determine if a net income or net loss occurs as follows:
a. Revenues > Expenses = Net Income.
b. Revenues < Expenses = Net Loss.

Here‟s more….

Assets

Assets are resources a business owns. The business uses its assets in carrying out such
activities as production and sales. The common characteristic possessed by all assets is the
capacity to provide future services or benefits.

Liabilities

Liabilities are claims against assets- that is, existing debts and obligations. Business of all sizes
usually borrow money and purchase merchandise on credit.

Owner’s Equity

The ownership claim on total assets is owner‟s equity. It is equal to total assets minus total
liabilities. Here is why: The assets of a business are claimed by either creditors or owners. To
find out what belongs to owners, we subtract the creditor‟s claims (the liabilities) from assets.
The remainder is the owner‟s claim on the assets- the owner‟s equity. Since the claims of
creditors must be paid before ownership claims, owner‟s equity is often referred to as residual
equity.

1. Increases In Owner’s Equity

In a proprietorship, owner‟s investments and revenues increase owner‟s equity.

A. Investments by Owner

Investments by owner are the assets the owner puts into the business. These
investments increase owner‟s equity. They are recorded in a category called owner‟s capital.

B. Revenues

Revenues are the gross increase in owner‟s equity resulting from business activities
entered into for the purpose of earning income. Generally, revenues result from selling
merchandise, performing services, renting property, and lending money. Revenue usually result
in an increase in an asst. They may arise from different sources and are called various names
depending on the nature of the business.

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2. Decrease in Owner’s Equity

In a proprietorship, owner‟s drawings and expenses decrease owner‟s equity.

A. Drawings

An owner may withdraw cash or other assets for personal use. We use a separate
classification called drawings to determine the total withdrawals for each accounting period.
Drawings decrease owner‟s equity. They are recorded in a category called owner‟s drawings.

B. Expenses

Expenses are the cost of assets consumed or services used in the process of
earning revenue. They are decreases in owner‟s equity that result from operating the business.

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Assessment Questions:

1. Describe the nature of a business, the role of accounting, and ethics in business.
2. Summarize the development of accounting principles and relate them to practice.
3. State the accounting equation and define each element of the equation.
4. Describe and illustrate how business transactions can be recorded in terms of the resulting
changes in the elements of the accounting equation.
5. Describe the financial statements of a proprietorship and explain how they interrelate.
6. Why is “Accounting” so important?
7. Why is the accounting equation set the way it is? Why could it not be “Owner‟s Equity –
Assets = Liabilities” or “Liabilities – Assets = Owner‟s Equity?”
8. Why are Net Income and Cash not the same?
9. Why do people call revenue by so many names?
10. Why do the financial statements have to go in a certain order?
11. Why is Cash the first asset listed?
12. What is the difference between revenues and assets?
13. What is the difference between expenses and liabilities?
14. Why does the balance sheet report the accounts at a point in time while the income
statement and statement of owner‟s equity report the activity for a period of time? Shouldn‟t
they all report for a period of time?
15. Can a non-CPA be a controller or chief accountant of an organization

CLASS DISCUSSION—Ethics in Accounting

Read one or more of the following cases and think whether or not the accountant acted
ethically.

1. Lauren Musni is the controller for Sports Central, a chain of sporting goods stores. She has
been asked to recommend a site for a new store. Lauren has an uncle who owns a
shopping plaza in the area of town where the new store is to be located, so she decides to
contact her uncle about leasing space in his plaza. Lauren also contacted several other
shopping plazas and malls, but her uncle‟s store turned out to be the most economical
place to lease. Therefore, Lauren recommended locating the new store in her uncle‟s
shopping plaza. In making her recommendation to management, she did not disclose that
her uncle owns the shopping plaza.

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2. John Juan is the chief accountant for the Southwest district office of Security Life Insurance
Company. While preparing the fourth-quarter sales report, John overheard the company
president say that he would close Security‟s Phoenix office if it did not meet its fourth-
quarter sales quota. John‟s best friend from college works at the Phoenix office.

Anxious to find out whether the office was in jeopardy, John immediately finished the
Phoenix office‟s report, only to find that it showed sales 25 percent below the quota. Later
that afternoon, the company president called John for Phoenix‟s sales results. John told the
president that he had not finished preparing the sales report for the Phoenix office. John
wanted time to compile data that might convince the president to continue operations in
Phoenix, despite lagging sales.

3. Tech-Smart Computer Company recently discovered a defect in the hard disks installed in
its model R24 computer. The hard disk head in these units retracts too violently whenever
the computers are turned off. As a result, the hard disks are destroyed after the computer is
turned on and off approximately 500 times. Tech-Smart has sold 4,000 model R24
computers nationwide.

The marketing department at Tech-Smart contacted most of the 4,000 owners of the model
R24 computer and discovered that 20 percent (or 800) use their computers in businesses
that operate 24 hours per day. These customers never turn their computers off; therefore,
the defect should not damage their hard disk units.

Judy Gorban, Tech-Smart‟s controller, has been asked to determine the cost to correct the
hard disk problem and recommend a course of action. After studying the marketing
department‟s report, Judy decides to recommend that Tech-Smart replace the hard drives
only in the 3,200 units used by customers who actually turn their computers off.

4. Tomas Bulaw, the controller for MicroTech Software Company, is responsible for preparing
the company‟s financial statements. He learns that sales for the first quarter of the year
have dropped so dramatically that the company is in danger of bankruptcy. As a result, he
applies for an accounting position with another software company that competes with
MicroTech. During his job interview, Tomas is asked why he wants to leave MicroTech. He
replies truthfully, “The company sales are down another 10 percent this quarter. I fear they
will go out of business.” At that time, MicroTech had not released its sales results to the
public.

Sources:

1. Weygandt, Jerry J, Kimmel, Paul D.,Kieso, Don E; Accounting Principles, 2016

2. Kimwell, Mercedes, Fundamentals of Accounting, 2015

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