MODULE 1

INTRODUCTION TO ACCOUNTING

Intended Learning Outcomes

After the end of this module, you should be able to:

1. define what accounting is and its purpose;
2. identify the users of financial information;
3. discuss the branches and areas of accounting;
4. distinguish the various forms of business organization;
5. describe the types of business;
6. describe the various accounting concepts and principles;
7. describe the qualitative characteristics of useful financial information
8. define and identify the different types financial statements; and
9. describe the elements of financial statements.

Accounting: Its Definition and Purpose

There are many definitions of accounting that have been issued by various organizations. The following
are some of those definitions:
 Accounting is a service activity. Its function is to provide quantitative information, primary financial
in nature, about economic entities, that is intended to be useful in making economic decisions and
alternative courses of actions- Accounting Standards Council (ASC), succeeded by Financial
Reporting Standards Council (FRSC)
 Accounting is the 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 financial character and interpreting
the results thereof. - American Institute of Certified Public Accountants (AICPA)
 Accounting is the process of identifying, measuring and communicating economic information to
permit informed judgment and decision by user of the information. - American Accounting
Association (AAA)
 Accounting is considered as language of business. It is a system that measures business activities,
processes that information into reports and communicates the results to decision-makers.

The purpose of accounting is to provide financial information to statement users so that they could make
informed judgement and better decisions. Without accounting, a business couldn’t function optimally; it
wouldn’t know whether it’s making a profit and it wouldn’t know its financial situation.

Users and Their Information Needs

Decision-makers need information. The more important decision is, the greater is the need for reliable
information. Virtually all business and most individuals keep accounting records to aid them in making
decisions. The users utilize financial information to satisfy some of their different need for information.
A. Internal Users - are users of financial information who are found inside the business entity.
 Owners use the information to know whether their business is prospering or not. They also use
the information to manage their business.
 Managers and supervisors are interested in the information about the operations of the business
since they will use it to strategize their management of the business.
 Employees are interested in information about the stability and profitability of their employers.
They are also interested in information which enables them to assess the ability of the enterprise
to provide salaries, retirement benefits and employment opportunities.
B. External Users- are users of financial information who are not part of the business but are outsider
whom the business transacts with.
 Investors need information to help them determined whether they should buy, hold or sell.
 Lenders are interested in information that enables them to determine whether their loans and the
related interest will be paid when due.
 Suppliers and other trade creditors are interested in information that enables them to determine
whether amount owing to them will be paid when due.
 Customers have an interest in information about the continuance of the enterprise, especially
when they have long-term involvement with, or are dependent on, the enterprise.
 Government and its agencies are interested in the allocation of resources therefore, the activities
of the enterprises.

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  Public. Financial statements may assist the public by providing information about the trends and
recent developments in the prosperity of the enterprises and the range of its activities.

Branches of Accounting
 Financial Accounting is focused on the recording of business transactions and the periodic
preparation of reports on financial position and results of operations. Financial accountants accord
importance to existing accounting standards.
 Management Accounting, as defined by Institute of Management Accountants (IMA) is 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 organization’s strategy.
 Cost Accounting deals with the collection, allocation and control of the cost of producing specific
goods and services.
 Auditing is an independent examination that ensures the fairness and reliability of the reports that
management submits to users outside the business entity.
 Government Accounting is concerned with the identification of the sources and uses of government
funds.
 Tax Accounting includes preparation of tax returns and the consideration of tax consequences of
proposed business transactions.
 Accounting Education employs accountants either as researchers, professors or reviewers. They
guarantee the continued development of the profession.

Forms of Business Organization

A business entity is an organization that uses economic resources or inputs to provide goods or services
to customers in exchange of money or other goods or services. These are the basic forms of business
organization:
 Sole proprietorship is a business owned only by one person. It is easy to set-up and is the least
costly among all forms of ownership. The owner faces unlimited liability which means that the
creditors of the business may go after the personal assets of the owner of the business cannot pay
them. This form of business is usually adopted by small business entities.
 Partnership is an association of 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. This form
of business needs to submit an Articles of Co-partnership to the Securities and Exchange
Commissions (SEC).
 Corporation is an artificial being created by law having the rights of succession, and the powers and
the attributes expressly authorized by law or incident to its existence. This form of business needs
to submit an Articles of Incorporation to the Securities and Exchange Commissions (SEC).
Ownership for a stock corporation is represented by shares of stock and the person handling the
shares of stock is known as a stockholder. 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.
 Cooperative is a business owned by a group of individuals and is operated for their mutual benefit.
The persons making up the group are called members. Some examples are cooperative banking,
credit unions and multi-purpose cooperatives.

Types of Business
 Service business provides intangible products (products with no physical form). They usually offer
professional skills, expertise, advise and other similar products. Example of service businesses are
salons, repair shops, schools, banks, accounting and law firms.
 Merchandising business is a business that buys products and sells the same. They are known as
“buy and sell” businesses. They make profit by selling the products at prices higher than their
purchase costs. It sells products without changing its form. Examples are grocery stores, department
stores and convenience stores.
 Manufacturing business buys products with the intention of using them as materials in making a
new product. Thus, there is a transformation of the products purchased. The manufactured goods
will then be sold to customers.
 Hybrid businesses are companies that may be classified in more than one type of business. A
restaurant, for example, combines ingredients in making a fine meal (manufacturing), sells a cold
bottle of wine (merchandising) and fills customers’ orders (service). Nonetheless, these companies
may be classified according to their major business interest. In that case, restaurants are more of the
service type- they provide dining services.

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Accounting Concepts and Principles
Accounting practices follow certain guidelines. The set of guidelines and procedures that constitute
acceptable accounting practice at a given time is known as generally accepted accounting principles
(GAAP).
 Business Entity Concept. It states that the account the transactions of different entities separately.
The business is separate and distinct from the owners. Thus, the business should only record the
transactions of the business.
 Periodicity Concept. An entity’s life can be meaningfully subdivided into equal time periods for
reporting purposes.
 Stable Monetary Unit Concept. The Philippine peso is a reasonable unit of measure and that its
purchasing power is relatively stable in the Philippine setting. This is the basis of ignoring the effects
of inflation in the accounting records.
 Going Concern. It is the underlying assumption which states that the company will continue in
operation for the foreseeable future. Hence, it is assumed that the enterprise has neither the intention
nor the need to liquidate.
 Accrual Basis. This states that revenues are recognized when it is earned (means services have been
performed or the goods have been delivered) regardless when the cash is received; and expenses are
recognized when it is incurred (means used or expired) regardless when the cash is paid.
 Matching Principle. This directs a company to report an expense on its income statement in the
same period as the related revenue is recorded.

Qualitative Characteristics of Useful Financial Information

The qualitative characteristics of useful financial reporting identify the types of information are likely
to be most useful to users in making decisions about the reporting entity based on information in its financial
report. The qualitative characteristics apply equally to financial information in general purpose financial
reports as well as to financial information provided in other ways. Financial information is useful when it
is relevant and represents faithfully what it purports to represent. The usefulness of financial information is
enhanced if it is comparable, verifiable, timely and understandable.
A. Fundamental qualitative characteristics
 Relevance. Relevant financial information is capable of making a difference in the decisions made
by users. Financial information is capable of making a difference in decisions if it has predictive
value, confirmatory value, or both. The predictive value and confirmatory value of financial
information are interrelated.
 Faithful representation. General purpose financial reports represent economic phenomena in words
and numbers, to be useful, financial information must not only be relevant, it must also represent
faithfully the phenomena it purports to represent. This fundamental characteristic seeks to maximize
the underlying characteristics of completeness, neutrality and freedom from error.
B. Enhancing qualitative characteristics
 Comparability. Information about a reporting entity is more useful if it can be compared with a
similar information about other entities and with similar information about the same entity for
another period or another date. Comparability enables users to identify and understand similarities
in, and differences among, items.
 Verifiability. Verifiability helps to assure users that information represents faithfully the economic
phenomena it purports to represent. Verifiability means that different knowledgeable and indepen-
dent observers could reach consensus, although not necessarily complete agreement, that a particular
depiction is a faithful representation.
 Timeliness. Timeliness means that information is available to decision-makers in time to be capable
of influencing their decisions.
 Understandability. Classifying, characterizing and presenting information clearly and concisely
makes it understandable. While some phenomena are inherently complex and cannot be made easy
to understand, to exclude such information would make financial reports incomplete and potentially
misleading. Financial reports are prepared for users who have a reasonable knowledge of business
and economic activities and who review and analyze the information with diligence.

Financial Statements
The financial statements are the means by which the information accumulated and processed in financial
accounting is periodically communicated to the users. Without accounting information embodied in the
financial statements, users may not be able to arrive at sound economic decisions. Per Philippine
Accounting Standards (PAS) 1, the objective of financial statements is to provide information about the
financial position, financial performance and cash flows of an entity that is useful to a wide range of users

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in making economic decisions. A complete set of financial statements includes the following components,
per PAS 1:
 Income Statement or Statement of Comprehensive Income presents a summary of the revenues
and expenses of an entity for a specific period.
 Statement of Changes in Equity or Statement of Changes in Equity or Capital Statement presents
summary of the changes in capital such as investments, net income or net loss, and the withdrawals
during the period.
 Balance Sheet or Statement of Financial Position lists all the assets, liabilities and equity of an
entity as at a specific date.
 Statement of Cash Flows or Cash Flows Statement reports the amount of cash received and
disbursed during the period.
 Notes to Financial Statements includes narrative descriptions or more detailed analyses of amounts
shown on the above financial statements.

Elements of Financial Statements

Financial statements portray the financial effects of transactions and other events by grouping them into
broad classes according to their economic characteristics. These broad classes are termed the elements of
financial statements.
A. The elements directly related to financial position (balance sheet) are:
 Asset. An asset is a resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity.
 Liability. A liability is a present obligation of the entity arising from past events, the settlement
of which is expected to result in an outflow from the entity of resources embodying economic
benefits.
 Equity. Equity is the residual interest in the assets of the entity after deducting all its liabilities.
B. The elements directly related to performance (income statement) are:
 Income. Income is increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases of liabilities that result in increases in equity,
other than those relating to contributions from equity participants.
The definition of income encompasses both revenue and gains. Revenue arises in the course
of the ordinary activities of an entity and is referred to by a variety of different names including
sales, fees, interest, dividends, royalties and rent. Gains represent other items that meet the
definition of income and may, or may not, arise in the course of the ordinary activities of an entity.
Gains represent increases in economic benefits and as such are no different in nature from
revenue.
 Expense. Expenses are decreases in economic benefits during the accounting period in the form
of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity,
other than those relating to distributions to equity participants.
The definition of expenses encompasses losses as well as those expenses that arise in the
course of the ordinary activities of the entity. Expenses that arise in the course of the ordinary
activities of the entity include, for example, cost of sales, wages and depreciation. They usually
take the form of an outflow or depletion of assets such as cash and cash equivalents, inventory,
property, plant and equipment. Losses represent other items that meet the definition of expenses
and may, or may not, arise in the course of the ordinary activities of the entity. Losses represent
decreases in economic benefits and as such they are no different in nature from other expenses.

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/NABergonia2017

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