DM 2 223 FINANCIAL MANAGEMENT Lecture 1

INTRODUCTION TO ACCOUNTING

ACCOUNTING
“It is the process of identifying, measuring, and communicating economic information to permit
informed judgments and decisions by the users of information.” -American Accounting Association (AAA)

“It 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 a financial character and interpreting the results thereof.” -
American Institute of Certified Public Accountants (AICPA)

ACCOUNTING PROCESS
1. Identification of economic events relevant to business.
– There should be a transfer of things with value.
2. Recording of relevant economic events.
– It should be done systematically and chronologically for easier tracking and interpretation.
Records of events are inputted in the accounting books.
3. Communicating economic information.
– Summarizes all the recorded economic events into accounting reports (financial statements).

NATURE OF ACCOUNTING
• Accounting is a process.
• Accounting is an art.
• Accounting deals with financial information and transactions.
• Accounting is a means and not an end.
• Accounting is an information system.

FUNCTIONS OF ACCOUNTING
• Keeping systematic record of business transactions
• Protecting properties of business
• Communicating results to various parties in or connected with the business
• Meeting legal requirements

HISTORY OF ACCOUNTING
• Dated back to ancient Mesopotamia - people followed a system of writing and counting money

• Reign of Emperor Augustus (63BC-14AD) - Roman government kept detailed financial information of
the deeds of the emperor regarding the stewardship of resources evidenced by Res Gestae Divi Augusti
(The Deeds of the Divine Augustus)

• Luca Pacioli – double-entry bookkeeping in the 14th century Italy

– known as the father of modern accounting
– Summa de arithmetica, geometria, proportioni et Proportionalita

• Modern Profession of the chartered accountant - originated in Glasgow, Scotland in the 19th century

BRANCHES OF ACCOUNTING
1. Financial Accounting
➢ Definition - handling the recording of financial transactions of a business
➢ Report - Financial statements
➢ Purpose - guide internal and external users in economic decisions
➢ Frequency - periodic
➢ Intended Users - external and internal users
➢ Standards - PFRS and PAS (Philippine Financial Reporting Standards & Philippine Accounting
Standards)

2. Management Accounting
➢ Definition - preparation of financial reports used by managers in their day-to-day decision-
making
➢ Report - management reports
➢ Purpose - help management in decision-making
➢ Frequency - whenever management asks for report
➢ Intended Users - internal users
➢ Standards - none

Instructor: Danica M. Almario, CPA 1

DM 2 223 FINANCIAL MANAGEMENT Lecture 1

3. Government Accounting
➢ Definition - accounting for the receipt and disposition of government fund
➢ Report - periodic financial reports and financial statements
➢ Purpose - show stewardship of public funds by the government
➢ Frequency - periodic
➢ Intended Users - external and internal users
➢ Standards – NGAS (New Government Accounting System)

4. Auditing
➢ Definition - unbiased examination and evaluation of the financial statements of an organization
independently
➢ Report - auditor's report
➢ Purpose - give credibility to the financial statements of a company
➢ Frequency - after every audit
➢ Intended Users - external users
➢ Standards – PSA (Philippine Standards on Auditing)

5. Tax Accounting
➢ Definition - lays down the different treatments of the taxing authorities regarding financial
transactions
➢ Report - tax returns
➢ Purpose - helps in determining the amount of taxes payable
➢ Frequency - periodic
➢ Intended Users - taxing authorities
➢ Standards – NIRC (National Internal Revenue Code)

6. Cost Accounting
➢ Definition - provides information for management accounting and financial accounting
➢ Report - cost of production report and other cost reports
➢ Purpose - find the cost of particular object
➢ Frequency - whenever management asks for report
➢ Intended Users - internal users
➢ Standards - none

7. Accounting Education
➢ Definition - promulgation of accounting knowledge to various interested parties that will aid
them in achieving their individual goals
➢ Report - none
➢ Purpose - educate students in the field of accountancy
➢ Frequency - none
➢ Intended Users - students and members of the academe
➢ Standards - none

8. Accounting Research
➢ Definition - continuous improvement of accountancy field through researches and studies
➢ Report - research results
➢ Purpose - add to the knowledge of accountancy
➢ Frequency - varies
➢ Intended Users - primarily members of the academe
➢ Standards - none

USERS OF ACCOUNTING INFORMATION

Internal Users
• Internal users of accounting information are those individuals inside a company who plan, organize,
and run the business.
• These users are directly involved in managing and operating the business.
• These include marketing managers, production supervisors, finance directors, company officers and
owners.

Instructor: Danica M. Almario, CPA 2

DM 2 223 FINANCIAL MANAGEMENT Lecture 1

Types of Internal Users

1. Management – Employees that can make decision for the company
➢ Information need: income/earnings for the period, sales, available cash, production
cost
➢ Decisions supported: Analyze the organization's performance and position and take
appropriate measures to improve the company results. Sufficiency of cash to pay
dividends to stockholders; pricing decisions

2. Employees – Persons in the company that do not have authority to implement decisions
➢ Information need: profit for the period, salaries paid to employees
➢ Decisions supported: Job security, consider staying in the employ of the company or
look for other employment opportunities

3. Owners/Stockholders – Existing investors of the company

➢ Information need: profit or income for the period, resources or assets of the
business, liabilities of the business
➢ Decisions supported: Considerations regarding additional investment, expanding
the business, borrowing funds to support any expansion plans

External Users
• External users are individuals and organizations outside a company who want financial information
about the company. These users are not directly involved in managing and operating the business.
• The two most common types of external users are potential investors and creditors. Also included as
external users are government regulatory agencies such as Securities and Exchange Commission (SEC),
Bureau of Internal Revenue (BIR), Department of Labor and Employment (DOLE), Social Security System
(SSS), and Local Government Units (LGUs).

Types of External Users

1. Customers - main source of income of businesses; for assessing the financial position of its suppliers
which is necessary for them to maintain a stable source of supply in the long term.

2. Creditors - providers of additional funds when initial investment is exhausted; lend resources to
businesses; for determining the credit worthiness of an organization. Terms of credit are set by creditors
according to the assessment of their customers' financial health. Creditors include suppliers as well as
lenders of finance such as banks.

3. Potential Investors - providers of additional funds when initial investment is exhausted; invest resources
in the business hoping to earn decent returns.

4. Tax Authorities (BIR) - for determining the credibility of the tax returns filed on behalf of a company.

5. Academe - uses accounting information primarily for academic purposes.

6. General Public - citizens and residents of the country; use financial statements to gauge economic
condition.

7. Regulatory Authorities (SEC, DOLE) - for ensuring that a company's disclosure of accounting information
is in accordance with the rules and regulations set in order to protect the interests of the stakeholders
who rely on such information in forming their decisions.

SUMMARY OF THE DIFFERENCES BETWEEN INTERNAL AND EXTERNAL USERS

Internal users of accounting information are those who are involved in planning, organizing and running the
business. They need more detailed information on a timely basis in order to support their decisions. Examples of
these internal users are managers, employees and owners.

The external users of accounting information are those individuals or organizations outside a company who are
interested in its financial information. Examples of these external users are potential investors, suppliers and
government agencies.

Instructor: Danica M. Almario, CPA 3

DM 2 223 FINANCIAL MANAGEMENT Lecture 1

FORMS OF BUSINESS ORGANIZATIONS

1. Sole Proprietorship
➢ only one owner
➢ no separate legal existence
➢ can take fictitious or trade names
➢ most common form of business organization
➢ easiest to establish

ADVANTAGES DISADVANTAGES
1. ease of formation 1. unlimited liability
2. owner has full control 2. difficulty of raising additional capital
3. owner can freely mix personal assets with 3. owner’s bias
business assets
4. owner has all the profits for himself or
herself
5. simple taxation

2. Partnership
➢ contract whereby two or more persons bind themselves to contribute money, property, or industry
to a common fund, with the intention of dividing profits among themselves
➢ may also be formed for the exercise of a profession
➢ Features – separate legal existence, mutual agency, unlimited liability, limited life, co-ownership of
partnership property, partnership agreement

ADVANTAGES DISADVANTAGES
1. easier to create than a corporation 1. unlimited liability
2. better ability to acquire additional capital 2. mutual agency
than sole proprietorships 3. limited life
3. larger pool of human capital than sole
proprietorships

3. Corporation
➢ artificial being created by the operation of law, having the right of succession and the powers,
attributes and properties expressly authorized by law or incident to its existence
➢ Features – separate legal existence, limited liability, transferable ownership rights, virtually
unlimited life, corporation management, double taxation
➢ Types of Dividends – cash dividends, stock dividends, property dividends

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
5. large pool of human capital

4. Cooperative
➢ 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

TYPES OF BUSINESS ACCORDING TO ACTIVITIES

1. Service
➢ Definition - generally use their employees to provide services to customers
➢ Input - labor
➢ Output - intangible; service
➢ Advantages - absence of inventory; no production facilities
➢ Disadvantages - inability to standardize services; maintaining human capital

Instructor: Danica M. Almario, CPA 4

DM 2 223 FINANCIAL MANAGEMENT Lecture 1

2. Merchandising
➢ Definition - buy finished or almost finished goods from suppliers and resell the same to
customers
➢ Input - goods or merchandise bought from suppliers
➢ Output - tangible; merchandise
➢ Advantages - visible products; less conversion, time and effort
➢ Disadvantage - managing inventory

3. Manufacturing
➢ Definition - create their own products
➢ Input - raw materials, labor, overhead
➢ Output - tangible; manufactured products
➢ Advantages - visible products; quality control
➢ Disadvantages - generally need production facilities; high conversion costs; cost of quality
control; managing inventory

4. Hybrid
➢ This type of business that may be classified under more than one type of business.

ACCOUNTING CONCEPTS AND PRINCIPLES

1. Going Concern Assumption
➢ Assumption that an entity will continue operations indefinitely in the future
➢ Can be abandoned if there are evidences supporting the contrary
Example: When preparing financial statements, you should assume that the entity will continue
indefinitely.

2. Cash Basis of Accounting

➢ Opposite of accrual basis of accounting
➢ Recognizes income when cash is received and recognizes expenses when cash is paid

3. Accrual Accounting
➢ Basis wherein income is recognized when earned and expenses are recognized when incurred
irrespective of the timing of cash receipt or payment
➢ Results in more accurate financial statements
Example: When a barber finishes performing his services, he should record it as revenue of the barber
shop. When the barber receives an electricity bill, it should record it as an expense of the barber shop
even if it is unpaid.

4. Monetary Unit Principle

➢ Amounts are stated into a single monetary unit.

Examples:
• Jollibee should report financial statements in pesos even if they have a store in the United States.
• IHOP should report financial statements in dollars even if they have a branch here in the
Philippines.

5. Materiality Principle
➢ In case of assets that are immaterial to make a difference in the financial statements, the
company should instead record it as an expense.
Example: A school purchased an eraser with an estimated useful life of three years. Since an eraser is
immaterial relative to assets, it should be recorded as an expense.

6. Matching Principle
➢ Closely related to accrual basis of accounting
➢ Expenses are recorded in the same period as the related revenues
Example: When you provide tutorial services to a customer and there is a transportation cost incurred
related to the tutorial services, it should be recorded as an expense for that period.

7. Objectivity Principle
➢ Financial statements must be presented with supporting evidence.
Examples:
• When the customer paid Jollibee for their order, Jollibee should have a copy of the receipt to
represent as evidence.
• When a company incurred a transportation expense, a voucher should be prepared as evidence.

Instructor: Danica M. Almario, CPA 5

DM 2 223 FINANCIAL MANAGEMENT Lecture 1

8. Business Entity Principle

➢ A business enterprise is separate and distinct from its owner or investor.
Examples:
• If the owner has a barber shop, the cash of the barber shop should be reported separately from
personal cash.
• The owner had a business meeting with a prospective client. The expenses that come with that
meeting should be part of the company’s expenses. If the owner paid for gas for his personal use, it
should not be included as part of the company’s expenses.

9. Accounting Judgement and Estimates

➢ Used because not all items in a company’s accounting records can be determined precisely
➢ Estimates – determined using professional judgment, study of historical data, and research

10. Prudence
➢ Also called conservatism
➢ Exercising care in decisions regarding recognition of items in the accounting records
➢ In case of doubt, recognize liabilities and expenses and do not recognize assets and income.
Example: In case of doubt, expenses should be recorded at a higher amount. Revenue should be
recorded at a lower amount.

11. Cost Principle

➢ Accounts should be recorded initially at cost.
Examples:
• When Jollibee buys a cash register, it should record the cash register at its price when they bought
it.
• When a company purchases a laptop, it should be recorded at the price it was purchased.

12. Time-Period Assumption

➢ Assumption that the indefinite life of a company can be divided into multiple time periods with
equal lengths
• Calendar year – 12-month period that ends on December 31
• Fiscal year – 12-month period that ends on any month

GAAP – Generally Accepted Accounting Principles

➢ Set of accounting principles, concepts, rules, and guidelines that companies follow
➢ It enhances the consistency and comparability of their financial statements.

IFRS – International Financial Reporting Standards

➢ Pronouncements made by the IASB
➢ Intended to enhance the consistency and comparability of the financial statements of the companies all
around the world.

PFRS – Philippine Financial Reporting Standards

➢ Philippine version of IFRS
➢ Includes the pronouncements of the IFRS, the PAS which corresponds with the IAS, and the
interpretations of accounting standards by the Philippine Interpretations Committee (PIC)

Instructor: Danica M. Almario, CPA 6