THE BASIC BUSINESS ENVIRONMENT

• The success of a business hinges on quality service and people. Accounting will show how the three kinds of
activities are transformed into relevant financial reports to help the stakeholders make right and timely decisions.
This chapter will illustrate the business activities, and how these are summarized into financial reports. The last
pages explain the financial information provided by the financial reports - profitability, liquidity, and solvency.
• A summary of the very essence of accounting, its concepts, and financial reports in Fig 1.2 next slide shapes the
accounting environment. The shape is further crystallized with the preparation of the formal accounting records and
the proper presentation of the financial reports in Chapters 5 to 7.

A) Explain Net Worth

• Net worth is about your wealth and is measured in the form of properties or assets.
• If you do not owe anybody, that means no obligations to be paid, then this wealth is your net worth.
• Wealth or net worth gives a picture of your financial state. To measure net worth or wealth, you have to put a
value or price to the assets or properties owned:

. A) Define Assets and Liabilities

• Assets include cash and other properties owned, be it personal or real. It represents your net worth if there are no
obligations or debts.
• But what if you purchased the laptop for P40,000 using a credit card? Then not all your assets really belong to you
as the credit company has a claim over the laptop until it is fully paid. The obligation to the credit company or what
you owe is called liability. From total assets of P96,000 deduct the liability of P40,000, this time your net worth
(assets that you can really call your own) will only be P56,000

What is Net Worth and Why is this Important?

• Net worth represents your Wealth or Finance which is made up of properties or assets. You probably own several
gadgets such as computer, cellphone, iPad, iPhone, as well as clothes, shoes, bags and which amount to two hundred
thousand pesos (P200,000). These are your ASSETS that make up your wealth or NET WORTH. However, if the
computer was purchased for forty thousand pesos (P40,000) using a credit card, then not all the assets belong to
you. The credit company has a claim over the computer. This is a LIABILITY or obligation to pay which will
decrease your net worth from P200,000 assets minus P40,000 liability equals your NET WORTH, which is now
only P160,000 in Philippine pesos.
• Net Worth affects your status in life. For one, a big net worth means a stable life. Second, knowing how much
your net worth is helps you plan on how to improve it and make it grow. Knowing how much your net worth at the
end of every year will give you a clear picture of where your wealth or finances are going. Has it been growing (if
you have more assets than liabilities) or deteriorating? From your P160,000 net worth, if you borrow cash of
P50,000, will your net worth improve? No. Although your assets will grow, so will your liabilities, too. It is only
profit that will make your net worth grow. You must put up a business to earn profit and make your net worth grow.

A) Explain net worth in an Accounting Equation

• Accounting equation for net worth:

• Assets P96,000 – Liability P40,000 = Net Worth P56,000
• Liabilities have priority over assets. Your claim is measured after liabilities have been considered.
• The equation can be expressed another way:
• Assets 96,000 = Liabilities 40,000 + Net Worth 56,000
 • Net worth is also called owner’s equity, appropriately termed if you are talking about your own business venture.
• THE BEST WAY FOR YOUR NET WORTH TO GROW IS TO PUT UP A BUSINESS.

Learning Outcome B. Business, and Accounting as Information Provider

Accounting as a Business Language

• Accounting is defined as a service activity whose function is to prepare financial reports that will provide
relevant information about the business. It is difficult for users to make financial decisions that are not supported
by facts. These facts are contained in the accounting reports. Accounting may also be defined as a process of
recording, classifying and summarizing transactions and events which are financial in nature and interpreting the
results thereof.
• Accounting is a bridge between the company and the interested parties or statement users. From the business
activities which accounting accumulates, reports will be prepared, and vital information communicated to the users.
Accounting speaks in a language that users must understand, so that when they read the reports, they will know
what information it is trying to convey to the interested parties.

BUSINESS ACTIVITIES ACCOUNTING REPORTS STAKEHOLDERS

The Basic Business Activities

• If you are using your money for a business venture, you must track down the following activities: from the money
you put in, you buy goods and sell this at a mark-up and collect the monies from the customers. Of course, you may
need cash to pay for rent, telephone, light and water to operate the business. Be sure you receive more money from
customers/clients than what you spend for the cost of goods or services. The difference between what you received
and what you paid is called profit.

Types of Business Operation

Services

• Provides service to clients and customers. Examples: beauty parlor, school, travel agency and airline.
Merchandising

• Buys and sells good to customers. Examples: shoe store, bookstore, drugstore, and supermarket.
Manufacturing

• Buys raw materials and converts these into finished products before selling to customers. Example: Garment
factory, shoe factory, drug laboratory.

B) The Role of Accounting

• Accounting does this for a business:

 • tracks down business activities,
• analyzes, calculates, and records these activities, and
• prepares a progress report
Accounting as a Language of Business

• Business Firms – Accumulate financial data through its various activities.

• Statement Users – Read the reports and decide.
• Accountants - Process the financial data and prepare financial reports.
Who Uses Accounting Data?
Internal Users

• Management
• Human Resources
• Finance
• Marketing
External Users

• BIR
• Investors
• Labor Unions
• Creditors
• SEC
• Customers
Types of Accounting Areas and the Reports Prepare
A. Internal reports called managerial reports are prepare for management use. Although management receives the
other reports, they also require additional information such as product cost, estimate of profit to be earned for a
planned project comparison of two alternative courses solving a problem, budgets, among others. This information
need gave rise to a course called Management Accounting.
B. The main source of information of stakeholders or users are the financial reports or the so-called general purpose
financial statements. This information need gave rise to a course called Financial Accounting. These reports are
audited by a Certified Public Accounting who attests to its fair presentation and validity making it reliable and
acceptable by the stakeholders.
C. All firms are required to pay taxes to the Bureau of Internal Revenue (BIR). This information need gave rise to a
course called Tax Accounting which specializes in the determination of taxes and preparation of various tax returns
required to be filled up by taxpayers such as: Income Tax, VAT, and Percentage Tax.
D. Some firms, by the nature of their organization/operation, are required to prepare special reports by certain
regulatory bodies. For example: bank prepare monthly, quarterly, and annual reports to be submitted to
Bangko Sentral ng Pilipinas. A business planner must submit to the Securities and Exchange Commission a
Plan of Merger.

C) Business Transaction
• A business starts with FINANCING activities. The owner “finances” the business with a startup capital in cash
and other resources. If owner’s contribution is insufficient, additional financing can be extended by banks and other
financing institutions. Financing activities also include withdrawals (capital withdrawn) made by the owner/investor
as well as loans repaid to lenders.
• As a business needs resources other than cash to be able to operate, it engages in INVESTING activities such as
the acquisition of properties in land, furniture, machineries, and equipment. Eventually these properties are disposed
or retired on its maturity date.
 • A business engages in OPERATING activities to earn profit. Related to earning of income will be receiving money
by selling goods or services. Related to incurring of expenses will be paying money for salaries and wages for
services of employees, for rent when using office space, for utilities when using electricity and water, for
transportation when riding in taxis, jeeps, and buses and many more.
Financial Reports
As mentioned in the early part of this chapter, there are four financial statements from which vital information can be
extracted:
a) Income Statement- shows how wealth is produced by listing the revenues earned and expenses incurred by the
business.
b) Statement of Owner’s Equity- shows why the net worth changed by listing the activities that caused it to increase
or decrease.
c) Statement of Cash Flows- shows what happened to the cash by enumerating the activities of cash received and
cash used by the business.
d) Statement of Financial Position- shows how the wealth of the business stands by enumerating the assets, liabilities
and net worth of the business.

How to assess the Doria business using the accounting reports:

The Income Statement or Profit Statement describes how the business operated or produced wealth over a period of one
month. It lists the revenues (reproduction service of P48,000) earned and the expenses (operating expenses of P16,000)
incurred by the business. A favorable operation called profit P32,000 was obtained since revenues exceeded expenses.
The Statement of Changes in Owner's Equity explains what happened to her net worth. It grew from P200,000 to P232,000
because of the profit. There are four activities affecting owner’s equity or net worth
1. Investment (P200,000)
2. Withdrawals (none)
3. Profit P32,000
4. Loss (none)