Unit 1: Introduction to Accounting

1.1 Definition, Purpose and Nature of Accounting

1.1.1 The Definition and Nature

Truth be told, we deal with accounting in our daily lives without us realizing it. The reason why
people do not realize this is because many of us have very limited to no background in
accounting at all.

The moment you order your hot or ice cold coffee, you tender your payment to the cashier and
in a few minutes you can enjoy your coffee. The coffee shop earns an income while you incur an
expense.

Someone who belongs to the working class will look into his earnings and budgets his funds to
be used for various living expenses. At times, he will keep track of his spending and savings.

The aforementioned cases deal with ACCOUNTING.

But what really is Accounting?

According to the Accounting Standards Council (ASC), ACCOUNTING is defined as:

- Service activity
Accounting is part of a profession. As such, it requires that someone be a professional
accountant to render accounting related services.

- About quantitative information & Financial in nature

The kinds of information that can be gathered through accounting do not involve
those that are qualitative but only quantitative and financial in character.
Anything that goes beyond financial character is no longer covered by accounting.

In other words, we are talking about monetary values.

- Useful in making economic decisions

The information generated through accounting can be channelled and used in making
economic decisions.

For example, if you want to diversify and introduce a new line of product, you would
have to consider the amount of your resources, existing liabilities, possible additional
labour, material and overhead costs to be incurred, etc. To guide yourself in making
the right decision, you will be asking yourself these questions:

“Will my cash position allow me to do this?” or “Will I be able to borrow money from the
bank to help me finance the new product line?”….“Should I sell some of my idle
properties to raise funds for this endeavour?

These questions can be answered by checking the financial information of your

business. The amount of your resources/properties, the amount of your financial
obligations, your income and expenses are recorded by your accountant and you can
access such needed information. Once you are able to lay down all that you need to
consider, you can make an economic decision.

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The American Institute of Certified Public Accountants (AICPA), on the other hand, mentions the
four functions of ACCOUNTING as part of its definition:
- recording (journal)
Technically, transactions have to be analysed first before they are being recorded. In
some references, you'll see that the 1st step is ANALYZING while some would start at
JOURNALIZING with the presumption that transactions have already been analyzed.

- classifying (ledger)
Entries from the journal are transferred to the ledger account per account.

- summarizing (trial balance)

Accounts from the ledger are presented in an organized fashion together with their
corresponding amounts.

- interpreting the results (financial statements)

This deals with the using of Financial Statements

The definition from the AICPA can best be reflected using the illustration below:

ANALYZE JOURNALIZE POST TO PREPARE

BUSINESS TRANSACTIONS LEDGER ACCOUNTS TRIAL BALANCE
TRANSACTIONS (Unadjusted)

REVERSING ADJUSTING
ENTRIES The Accounting Cycle ENTRIES

POST-CLOSING MAKE CLOSING PREPARE PREPARE

TRIAL BALANCE ENTRIES FINANCIAL ADJUSTED
STATEMENTS TRIAL BALANCE

1.1.2 The Purpose

In an actual setup, the business owner has to see and understand the things happening in his
business. To do that, it is a must that his transactions, debts, resources, income, and expenses be
kept tracked.

If the owner has no background in accounting, this is where the bookkeeper will come in.
Through the help of the bookkeeper, the recording function can be facilitated. The job of an
accountant/ bookkeeper, however, doesn’t just stop at recording as he also has to help the
business with the other three (3) functions.

Eventually, when the process is over, the accountant will prepare reports known as Financial
Statements. These are reports that summarize the resources (assets), obligations (liabilities),
capital, income and expenses of the business. By using the financial statements, it will be easier
for the business owner to have an understanding of how the business is doing—whether the
business is profiting or losing and whether it is financially ill or financially well.
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Users of Accounting Information

Investors – The information they need is related to deciding whether they should buy, sell or
hold their shareholdings or ownership in a business. If they see that the company is able to
pay for their dividends, this could be a factor for them to acquire or maintain their ownership
interest. A high level of earnings is one indicator of the company’s ability to pay dividends.

Employees – These people seek employment opportunities, benefits and security. They want
to assess the company’s profitability and stability. If a company is stable, profitable, and able
to provide benefits, employees would most likely stay.

Lenders – They are the people from whom the company borrows funds for business use. It is
in their interest to know if the company is in good shape and can pay back the loans. Lenders
would look into the company’s long term liabilities and resources (assets) to assess its
financial capacity.

Suppliers and other Trade Creditors – This group has an interest in knowing if amounts
owing to them will be paid upon maturity. They would look into the entity’s assets and
liabilities to decide whether to continue extending credit or not.

Customers – Over time, people (customers) may become highly involved or dependent upon
an enterprise. With this, this group of users would like to know about the company’s
continuance.

Government and their Agencies – Certain information are required by the government from
the businesses for activity regulation, taxation policies, etc.

Public – The general public normally would look into the business trends and recent
progress of an enterprise including the coverage of its activities.

Company Management – The people running the company also needs accounting
information as they have to decide about certain matters like expansion, cost-cutting, hiring,
etc. The information need is mainly for internal affairs.

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