BMSH2005

INTRODUCTION TO ACCOUNTING

Nature and Origin of Accounting

Accounting as the Language of Business

Accounting is the process of gathering financial information about a business and reporting this information to
its end users. Accounting is also called the language of business. (Cabrera, 2016)

The following are the three (3) widely-accepted definitions of accounting (Rabo, Tugas, & Salendrez, 2016):
• According to the American Accounting Association (AAA), accounting is the process of identifying,
measuring, and communicating economic information to permit informed judgment and decisions by
users of the information.
• American Institute of Certified Public Accountants (AICPA) defines accounting as 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.
• The Accounting Standards Council (ASC) see accounting as 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.

Nature of Accounting
Based on the definitions above, there are unifying themes that describe the nature of accounting (Rabo, Tugas,
& Salendrez, 2016):
• Accounting is an art. The word ‘art’ refers to the design 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.
• 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.
• It can also be assumed that accounting is a process. A ‘process’ 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 after.
In effect, accounting is also an ‘information system’. This is a set of interrelated components that work
together to achieve a common purpose. It also serves 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

Function of Accounting
An information system in itself, accounting performs the following tasks (Rabo, Tugas, & Salendrez, 2016):
• To fulfill the stewardship function of the management (or owners).
• To help interested users come up with informed decisions; and
• To support daily operations of the business.

Users of Accounting Information

The primary users of financial information are the following:
1. Internal Users – These are people within a business organization who use financial information.
• Managers – Those who plan, organize, and run the business.

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• Owners – They provide the capital to the business. Accounting information is needed by the owners
to help them decide whether they should withdraw or increase investments, as well as, determine
the return on their investment.
• Employees – Assess the company’s profitability and stability, its consequence on their future salary
and job security.

2. External Users – These are people outside the business entity (organization) who use the accounting
information of the company
• Investors – Financial information will help them decide whether they should invest or not in the
business.
• Creditors – They assess creditworthiness and the capability of the business to repay its obligation,
including the related interests on the maturity date.
• Customers – They have an interest in information about the continuance of an enterprise,
especially when they have a long-term involvement with, or are dependent on, the enterprise.
• 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 disclosure 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.

History and Development of Accounting

The origin of accounting and its subsequent development are best studied in the context of the history of
commercial transactions. During 8,500 B.C., in the Middle East region, tradesmen use clay objects to represent
commodities such as flocks of sheep, jars of spices and oil, bolts of clothing, and other goods.

The origins of accounting can be traced from the Renaissance period. Particularly, the Italian monk and
mathematician Friar Luca Bartolomes Pacioli born during 1445 in Sansepolcro, Tuscany. He was a
mathematician and friend of Leonardo da Vinci. He wrote and taught in many fields including mathematics,
theology, architecture, games, military strategy, and commerce. In 1494, Pacioli published his famous book
‘Summa de Arithmetica, Geometria, Proportioni et Proportionalita’ (The Collected Knowledge of Arithmetic,
Geometry, Proportion and Proportionality). A section of this book was dedicated to the description of double-
entry accounting (this will be discussed under ‘Recording Business Transactions’ topic). The Summa was one
of the first books published on the Gutenberg press, became an instant success and was translated into
German, Russian, Dutch, and English. The Summa made Pacioli a celebrity and ensured him a place in history,
as "The Father of Accounting" (deSantis, 1995).

In the mid-18th to 19th centuries, cost accounting emerged during this period. The corporate form of business
organization was created to accommodate the need for the increasingly large amount of funds required to
finance the expansion of large businesses.

Today, the generally accepted accounting principles, or GAAP, set forth the standards by which public
accountants must do business. Every country has a similar set of accounting guidelines.

Branches of Accounting
The main areas of accounting are:
1. Financial Accounting – The gathering, classifying, analyzing, recording of financial data in the books
of accounts and preparation of reports to management on the financial data. It involves bookkeeping –
the procedural aspect of recording financial data and preparing of reports (Reyes, 2016).

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2. Management Accounting – The gathering and reporting to management of data necessary for
management decisions (e.g., controlling cost, planning for future operations, discontinuing losing
operations, and distribution of income to stockholders) (Reyes, 2016).
3. Auditing
 Internal Auditing – Reviews 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 statements, for the statements’
acceptability to the public and to government regulatory agencies (Reyes, 2016).
4. 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).
5. 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).
6. Cost Accounting – Analyzes 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).

Specialized Accounting Fields

1. Public practice – Accountants in public practice are working in accounting firms or individually to
provide audit and attestation, tax planning and preparation, and advisory services to their clients.
2. Industry or Commerce – Accountants in private accounting provide a staff function that supports the
company by performing accounting-related tasks.
3. Government – Government agencies also need accountants. These agencies need accounting
information to help them plan, budget, forecast, and allocate government funds.
4. Academe – This area is made up of accountants who are into teaching, research, and training and
development.

Accounting Concepts and Principles

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. This has been developed by the accounting professionals to guide preparers
of financial statements in recording and reporting financial information regarding a business enterprise, hence
aiding in the effective execution of the accounting procedure and in communicating the financial condition of the
business (Rabo, Tugas, & Salendrez, 2016).

Underlying Assumptions (Rabo, Tugas, & Salendrez, 2016)

• Economic Entity or Business Entity Concept – It assumes that all of the business transactions are
separated from the owner’s personal transactions.
• Accrual Basis – It requires that all business transactions and other events are recognized in the
accounting records when they occur, rather than when the cash or equivalent is received or paid. It is
assumed that revenue is recorded in the period it is earned, regardless of the time the cash is received
or collected. Same with expense, it is recognized and recorded at the time it is incurred, regardless of
the time that cash is paid.
• Going Concern – This assumes that a company will continue to exist long enough to carry out its
objectives and commitments and will not liquidate in the foreseeable future.
• Monetary Unit – This assumes that only transactions that can be expressed in terms of money are
recorded. Economic activities of a Philippine entity are measured and reported in the Philippine peso.

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• Time-Period – It requires a business to complete the whole accounting process of a business over a
specific operating time period. It may be monthly, quarterly, semi-annually, or annually.
o Calendar Year – A 12-month period that ends on December 31.
o Fiscal Year – A 12-month period that may or may not end on December 31.

Basic Accounting Principles (Rabo, Tugas, & Salendrez, 2016)

• Cost Principle – Cost refers to the amount spent when an item was originally obtained, whether that
purchase happened last year or 10 years ago; amounts are not adjusted upward for inflation. The
amounts shown in financial statements are referred to as historical cost amounts.
• Full Disclosure Principle – In preparing financial statements, the accountant should include sufficient
information to permit the stakeholders to make an informed judgment about the financial condition of
the enterprise.
• Matching Principle – It requires that expenses be matched with revenues. Meaning, in a given
accounting period, the recorded revenue should have an equivalent expense recorded, in order to show
the true profit of the business.
• Revenue Recognition Principle – Revenues are recognized as soon as goods have been sold or a
service has been rendered, regardless of when the money is actually received.
• Materiality Principle – Business transactions that may affect the decision of a user of financial
information are considered important or material, and thus, must be reported properly.
• Conservatism Principle – It states that given two (2) options in the valuation of business transactions,
the amount recorded should be the lower value rather than the higher value. If a situation arises where
there are two (2) acceptable alternatives for reporting an item, conservatism directs the accountant to
choose the alternative that will result in less effect on net income and/or less asset amount.
• Objectivity Principle – It requires business transactions to have some form of impartial supporting
evidence or documentation. It also entails that bookkeeping and financial recording be performed with
independence that is free of bias and prejudice.

Forms of Business Organizations

In relation to the business entity concept, the following are the different forms of organizations:

1. Sole Proprietorship – This is the simplest form of business organization where only one (1) individual
owns the business (Frias, 2016 ). It is easy to set-up and is the least costly among all forms of
ownership.
2. Partnership – This is formed by two (2) or more individuals to carry on as owners of the business.
Article 1767 of the New Civil Code of the Philippines defined partnership as ‘contracts whereby two (2)
or more persons bind themselves to contribute money, property or industry to a common fund with the
intention of dividing the profits among themselves’ (Frias, 2016 ).
• General Partnership – Each partner has unlimited liability for the debts incurred by the business.
Usually manage the firm and may enter into contractual obligations on the firm’s behalf. Profits and
asset ownership may be divided in any way agreed upon by the partners (Cabrera, 2010).
• Limited Partnership – Contains one (1) or more general partners and one (1) or more limited
partners. The personal liability of a general partner for the firm’s debt is unlimited while the personal
liability of limited partners is limited to their investment. Limited partners cannot be active in
management (Cabrera, 2010).
3. Corporation – A separate body consisting of at least five (5) to 15 individuals treated by law as a unit.
According to Section 2 of the Corporation Code of the Philippines, a corporation is ‘an artificial being
created by operation of law, having the right of succession and the powers, attributes, and properties
expressly authorized by law or incident to its existence’ (Rabo, Tugas, & Salendrez, 2016).

The articles of incorporation include, among others, the following:

• Incorporators
• Name of the Corporation
• Purpose of the Corporation
• Capital Stock

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• Authorized Shares

After the corporation is legally formed, it will then issue its capital stock. Ownership of this stock is
evidenced by a stock certificate

Comparison of the Forms of Business Organization

SOLE PROPRIETORSHIP PARTNERSHIP CORPORATION

Ownership One (1) owner Two (2) or more Five (5) or more
Depends on the type of
Depends on the needs of Depends on the needs of the
Capitalization business as prescribed by
the business business
law
Management Managed by the sole Managed by one (1) or more Managed by the board of
Structure proprietor partners directors
1. Increased potentials from
1. Easy to form, easy to
two (2) or more different
dissolve.
strengths. 1. More source of funds.
2. Full control of operations.
2. Easy to form with proper 2. Easy to transfer
3. All profits go directly to
agreements on its ownership.
Advantages the owner.
formation. 3. Limited liability.
4. Less regulations.
3. Less regulations 4. Unlimited commercial
5. The government taxes
compared to corporations. life.
the owner, not the
4. Professional partnership
business.
is tax-exempt.
1. Unlimited liability – the 1. Unlimited liability of all 1. More regulations to be
owner is legally obliged partners. followed.
to pay all business debts. 2. Limited life – admission of 2. Profit is taxed by the
2. Limited life – the a new partner or the corporate tax rate.
business ceases to retirement/ withdrawal of a 3. Costly to incorporate.
Disadvantages
operate if the owner dies, partner dissolves the
becomes insane, or partnership.
imprisoned. 3. High possibility of dispute
3. Difficulty in raising and conflicts between
capital. partners.

Types of Business According to Activities

1. 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).
2. 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.
3. Service Business – Focuses on providing intangible products such as offering professional skills,
proposals, 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
Buys goods and sells in Converts raw materials
Activity Does work for others
the same form to finished goods
Nature of Revenue Sales Sales Service Income
Cost of Goods Sold Service Income
Cost of Goods Sold and
Cost and Expenses Selling & Administrative Cost of Service and
Manufactured
Expenses Administrative Expenses

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MERCHANDISING MANUFACTURING SERVICE

Selling & Administrative
Expenses
Form of Business Sole Proprietorship/Partnership/Corporation
1. Good merchandising 1. There is a continuous 1. No need for inventory.
attracts more demand for 2. Skills can be improved
customers. manufactured goods. and can produce
Advantages 2. It is flexible to 2. Job satisfaction can better service.
changes. be ensured through
the output of the
produced item.
1. It demands more work 1. Owners need to keep 1. Services are harder to
and workers. up with the high value.
2. It needs to manage overhead costs. 2. Less demand during
customer’s 2. The cost of the economic downturns.
expectations. manufactured
Disadvantages
3. It needs to budget products highly
expenses for depends on the price
occasional and availability of raw
improvements within materials.
the store.

References
Brigham Young University. (2015, September 10). What is accounting research? - PhD Prep Track. Retrieved
from PhD Prep.byu.edu:
http://www.byuaccounting.net/mediawiki/index.php?title=What_is_accounting_research%3F
Cabrera, M. B. (2016). Fundamentals of Accountancy, Business & Management Volume 1. Manila: GIC
Enterprises & Co., Inc.
deSantis, J. (1995). A Brief History of Accounting: From Pre History to the Information Age. Retrieved from
http://www.ftlcomm.com/ensign/historyAcc/ResearchPaperFin.htm
Frias, A. S. (2016 ). Fundamentals of Accountancy, Business, and Management: A Textbook in Basic
Accounting 1 . Quezon: Phoenix Publishing House.
Rabo, J. S., Tugas, F. C., & Salendrez, H. E. (2016). Fundamentals of Accountancy, Business and
Management 1. Quezon: Vibal Group, Inc.
Reyes, V. D. (2016). The Fundamentals in Accounting. Manila: GIC Enterprises & Co., Inc.
Weygandt, J. J., Keiso, D. D., & Kimmel, P. D. (2012). Accounting Principles. United States of America.

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