BOOKKEEPING NC III

MODULE I

INTRODUCTION TO ACCOUNTING
(Fundamental Theories and Principles of Accounting)

Objectives:
At the end of the chapter, the student will be able to:

1. Define accounting and its importance;

2. List down the nature, and functions of accounting in the business world;
3. Determine the scope and branches of accounting;
4. Describe the different types and forms of business;
5. Give examples of each type and forms of business;
6. Know the basic accounting assumptions and principles;
7. Identify and classify the different assets, liabilities, capital, revenues and expenses accounts;
8. Describe the basic financial statements of business; and
9. Recall the elements of financial statement of business.

Importance of Studying Accounting

In our day to day activities, we failed to realize that we have been working with accounting concept and
accounting information. Whatever we do, wherever we go which involve decision making, accounting is
unconsciously applied. It has always been part of our daily struggle for survival. Thus studying accounting is
beneficial to everyone regardless of whatever profession one has.

Accounting is the process of identifying, measuring and communicating economic information to permit
informed judgment and decisions by users of information. Accounting is vital to any business organization. It
is equally essential to the successful operation of non-profit organization, government units or agencies and to
non-government organization.

Importance of Accounting in Business

Profit is among the primary concern of any business organization. To be successful depends to a
great extent on the ability of the management to plan, control and render decisions. Management is likely to
give appropriate decision if furnished with relevant, accurate and timely data. With accounting, management
is provided with information essential to the effective conduct and evaluation of its business activities.

FORMS OF BUSINESS ORGANIZATION

Sole Proprietorship. This business organization is owned by one person called the proprietor who
generally is the manager. The owner receives all profits and absorbs all losses and is solely
responsible for the debt of the firm.

Partnership. Is owned by two or more persons who bind themselves to contribute money, property or
services to the common fund, with the intention of dividing the profits among themselves. Each partner
is personally liable for any debts of the firm. It is easily formed and dissolved.

Corporation. Corporation is an artificial being created by operation of law, having the rights of
succession and the powers, attributes and properties expressly authorized by law or incident to its
existence. It is owned by the stockholders and managed by the Board of Directors. Stockholders are
not personally liable for the corporation’s debt. The accumulated profit of a corporation is called
“Retained Earnings”. Stockholders receive their share in the profits of the corporation in the form of
“Dividends”.(5-15)
 In addition to those basic forms of business ownership, these are some other types of organizations
that are common today:

Limited Liability Company

Limited liability companies (LLCs) in the USA, are hybrid forms of business that have
characteristics of both a corporation and a partnership. An LLC is not incorporated; hence, it is not
considered a corporation.
Nonetheless, the owners enjoy limited liability like in a corporation. An LLC may elect to be taxed as a
sole proprietorship, a partnership, or a corporation.

Cooperative
A cooperative is a business organization owned by a group of individuals and is operated for
their mutual benefit. The persons making up the group are called members. Cooperatives may be
incorporated or unincorporated. Some examples of cooperatives are: water and electricity (utility)
cooperatives, cooperative banking, credit unions, and housing cooperatives.

Types of Business Activities

A Service Companies perform services for a fee. Law firm, Accounting Firm, hotels, parlor shops,
hospitals, transportations and communications services, and the like are typical examples of service
concern.

A Merchandising Company sells goods in substantially the same physical form it was acquired. It is
better known as “trading concern” or “buy and sell”. Hardware, bookstore, drugstore, department
store, supermarkets, sari-sari store and the like are good example of a merchandising concern.

A Manufacturing Company converts raw materials into finished product and sell them to other
companies or to end consumers. Multinational companies such as Dole, Pharmaceuticals, Cements,
Flours, Toyota Companies are engaged in producing their respective products.

An Agribusiness is engaged in the operations that are associated with farming like that of planting
crops and sells its product for a profit.

A 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 customer 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.

Accounting Information System

An accounting information system (AIS) is a structure that a business uses to collect, store,
manage, process, retrieve and report its financial data so that it can be used by accountants, consultants,
business analysts, managers, chief financial officers (CFOs), auditors and regulatory and tax agencies.

Realizing the significance of accounting information most business and non-business entity design and
install suitable AIS which will generate reliable financial information needed by the decision makers in a timely
manner. An Accounting Information System is the combination of personnel, records and procedures that a
business uses to meet its need for financial information.

An Accounting Manual is a guidebook that specifies the policies and procedures to be followed in
accumulating information within the Accounting Information System.
Keeping of Business Records as Required by Law

Maintaining a business record is a mandatory government requirement. Title IX, Chapter 1, Section
232A of the Internal Revenue Code of the Philippines requires all corporations, companies, partnerships or
persons which are required by law to pay internal revenue taxes to keep books of accounts and records in
accordance with the standard accounting system. It is also done in compliance with Municipal or City
ordinances regarding local business taxation.

Who does the Recording, Accounting and Examination Process?

Basically, a “bookkeeper” does the recording process while the “accountant” transforms accounting
data into a report form called “financial statements”. Accountants also analyze as well as interpret the report
thereof. Usually, accountant provides the owner with a guide and a basis for formulating and adapting
financial plans and policies that will lead to efficient management, thereby business goals and objectives are
attained. On the other hand, “Auditors” examines the financial statements that was prepared by the
accountant and renders an opinion as to its fairness and reliability of the report.

Generally Accepted Accounting Principle (GAAP)

Generally Accepted Accounting Principle are uniform set of accounting rules, procedures, practices
and standards that are followed in financial statement preparation. In the Philippines, the accounting
standards promulgated by the Accounting Standard Council constitute the GAAP.

Basic Accounting Concept/Assumptions

1. Accounting Entity Concept. This assumes that business has a separate and distinct personality
from that of the owner.
2. Going Concern Assumption. This assumes that the business has continuous life of existence
unless there is specific evidence to the contrary.

3. Periodicity Concept. This assumes that life of a business entity is meaningfully divided into equal
period such that financial statements are prepared every end of accounting period.

An Accounting Period can be a period of: 1-month (monthly basis); 3-months (quarterly basis); 6-
months (semi-annual basis) or 12-months (annual basis or yearly basis).

An accounting period of less than a year is called “fiscal period” and financial statements prepared
for less than a year are referred to as “interim financial statements”.

3 Kinds of Annual Accounting Periods:

1. Calendar Year – Accounting period that starts at January 1 and ends at December 31 of that
year.

2. Fiscal Year – Accounting period will begin on the first day of any month of the year except
January 1 and will end on the last day of the twelfth month completing the one year period.

3. Natural Business Year – is a twelve month period that ends on any month when the business is
at the lowest or experiencing slack season.

4. Unit of Measure Assumption. This assumes that peso is our unit of measure and the purchasing
power will not fluctuate and therefore, is stable.
 5. Accrual Basis Assumption. This assumes that recording of income and expense follow the
accrual basis of accounting, where income is recognized when earned regardless of when
received, and expense is recognized when incurred regardless on when paid.

Basic Accounting Principles

The following are among the basic accounting principle that guides accountant in the accumulation of
financial information:

1. Objectivity Principle. This principle states that accounting record and statement should be based
on the most reliable data available so that they will be as accurate and as useful as possible. All
records should be supported by evidences such as official receipts, bill of payments, vouchers,
payroll, and the like.

2. Historical Cost. This principle states that acquired assets should be recorded at their actual cost
not at what management think they are worth at reporting period.

3. Revenue Recognition Principle. Revenue is to be recognized in the accounting period when

tools are delivered or services are rendered or performed.

4. Matching Principle. Expenses should be recognized in the accounting period in which the goods
and services are used that produce revenue and not when the entity pays for those goods and
services.

5. Consistency Principle. The firm should use the same accounting method from period to achieve
comparability over time. However, changes are permitted if justifiable and is disclosed in the
financial statements.

6. Materiality. Financial reporting is only concerned with information that is significant enough to
affect evaluation and decision.

7. Conservatism. Frequently, assets and liabilities are measured in a context of major uncertainties.
Accountants generally choose a method or procedure that yield the lesser amount of income and
asset value. This attitude is often expressed in the statement “anticipate no profits and provide for
all losses”

8. Timeliness. Accounting information is communicated early enough to be used for the economic
decision that it might influence.

9. Adequate Disclosure. This requires that all relevant information that would affect the users’
understanding and assessment of the accounting entity be disclosed in the financial statements.

The Five (5) Elements of Financial Statements

1. Assets. Are things of value that are owned and used by the enterprise in its operation. Asset is
defined as “resources controlled by the enterprise as a result of past transactions and events and
from which future economic benefits are expected to flow to the enterprise”. Examples are cash,
accounts receivable, inventories, supplies, prepaid expenses, land, building, equipment, tools,
intangible assets and other assets.

2. Liabilities. Are financial obligation of the business to its creditors. It represents the claim of the
creditors over the assets of the enterprise. Liabilities are defined as “present obligations of an
enterprise arising from past transactions or events, the settlement of which is expected to result in
 and outflow from the enterprise of resources embodying economic benefits”. Examples are
accounts payable, accrued expenses, taxes payable, loans payable, bond payable, and others.

3. Owners’s Equity or Capital. Is the residual interest in the assets of the enterprise after deducting
all its liabilities. It is increased when there is Net Income or additional contribution by owner and
decreased when there is Net Loss or withdrawal by the owner. Capital is synonymous to
“Proprietorship”, “Proprietary Interest” or “Net Worth”, “Owner’s Equity”, “Partnership Equity” or
“Stockholders Equity” are the appropriate terms respectively for a Sole Proprietorship, Partnership,
and Corporation forms of enterprise.

4. Revenue. Is defined as “gross inflow of economic benefits during the period arising in the course
of ordinary activities of an enterprise when those inflows result in increase in equity, other than
those relating to contributions”. Examples are proceeds from services rendered by a servicing firm,
income from use by other entities of the resources of the enterprises like royalties income, rent
income, interest income, etc and sale of merchandise for trading firm.

5. Expense. Are the “gross outflow of economic benefits during the period arising in the course of
ordinary activities of an enterprise when those outflows result in decrease in equity, other than
those relating distribution to owners”. Examples are salaries expense, rent expense, supplies
expense, etc.

Net Income or Net Loss. The excess of revenues over expenses is called “Net Income” while
“Net Loss” occurs when expense exceeds the revenue.

The Financial Statements

The Financial Statements are the means by which the information accumulated and processed in
financial accounting are periodically communicated to the users. The objectives of financial statements is to
provide information about the financial position, performance and cash flows of the enterprise that is vital in
making a sound economic decision. There are (5) Five Basic Financial Statements as per ASC # 1, Revised
2000 namely:

1. Balance Sheet. It shows the financial position of an enterprise as of particular date. It shows the
Assets, Liabilities and Owner’s Equity thru which the enterprise liquidity, solvency, financial
structure and capacity for adaptation could be measured and evaluated.
2. Income Statement. It shows the performance of the enterprise for a given period of time. This
statement present the result of operation of an enterprise, which would either be a net income, net
loss, or break-even.

3. Statement of Changes in Equity. It summarizes the changes in equity for a given period of time.
The beginning equity of the owner is increased by the additional investment and net income.
Correspondingly, it is decrease by withdrawals and net loss.

4. Statement of Cash Flow. This provides information about cash inflows (receipts) and cash
outflows (payments) of an entity for a given period of time which are being classified into: a)
Operating Activities; b) Investing Activities; and c) Financing Activities.

5. Accounting Policies and Notes to Financial Statements. This is an additional statement and
considered also as basic statement. This presents significant accounting policies that affected the
financial statements and other disclosures necessary to make the financial statements more useful.
Users of Financial Statements:

1. Investors. They need information to help them determine whether they should add more or
withdraw their capital investment. Stockholders are interested on information which enables them
to assess the ability of the enterprise to pay dividend.

2. Employees. They are interested on information about the stability and profitability of the
enterprise. They are interested on information which enables them to assess the ability of the
enterprise to provide remuneration, retirement benefits and employment opportunities.

3. Lenders/Creditors. Are interested on information which enables them to determine whether their
loans and interest thereon will be collected when due.

4. Suppliers. They are interested on information which enables them to determine whether amounts
owing to them will be paid on maturity.

5. Customers. They have an interest on information about the continuance of an enterprise

especially when they have a long-term involvement with or are dependent on the enterprise.

6. Government and their agencies. These users require information to regulate the activities of an
enterprise, determine taxation policies and as a basis for national income and similar statistics.

7. Public. Enterprises affect members of the public in a variety of ways. For example, enterprises
make substantial contributions to the local economy in many ways including the number of people
they employ and their patronage of local suppliers. Financial statements may assist the public by
providing information about the trends and recent developments in the prosperity of the enterprise
and the range of its activities.

8. Management. They utilize information to set goals for their organization, to evaluate results of past
economic decision and to control activities of the entity. Managers use financial information for
planning, controlling, and for decision-making purposes.

(Note: 1-7 are referred to as external users, while 8 is considered internal users)

Accounting as “Language of Business”

The entity concept of accounting emphasize that “business has distinct personality separate from that
of the owner”. As a separate unit, the means thru which business communicates to owner and to various
interested parties about its performance, accomplishments, status and conditions are done thru the financial
statements. This accounting reports uses distinct technical terms or accounting terminologies which are
understandable in the business world. Thus, financial statements become the “bridge of communications”.
With the relevant quantitative information it provides to concerned parties, accounting is said to be the
“language of business entity”.
Accounting Defined

Accounting, according to American Institute of Certified Accountants is “the art of recording, classifying,
and summarizing in a significant manner and in terms of money transactions and events which are in part or in
form financial character and interpreting the results thereof.

Accounting is a service activity. Its function is to provide quantitative information primarily financial in
nature about economic entity that is intended to be useful in making economic decisions.
Phases of Accounting

The above definition implies the Four (4) major function of accounting namely:

Recording. Means putting into writings business transactions in chronological order, thru the double
entry bookkeeping method, in the journal and ledger books.

Classifying. Is the sorting or grouping of similar transactions or items. Classification reduces the
effects of numerous transactions into useful groups or categories.

Summarizing. Is done at the end of the accounting period thru the preparation of Financial
Statements or financial reports.

Interpreting. Is the analytical portion of accounting. Financial Statement will be meaningful and
beneficial to management if duly analyzed and interpreted.

Branches of Accounting

What Are the Main Branches of Accounting?

Accounting is a very interesting field. It has many branches “8” to be exact. After finishing this article,
the reader should have acquired an overview of the different branches of accounting, namely: financial
accounting, auditing, bookkeeping, management advisory services or management accounting, government
accounting, tax accounting, fiduciary accounting, and accounting systems installation.

Financial Accounting – this branch of accounting deals with the journalizing of business transactions,
preparation of financial statements, and communicating the information about the economic effects of the
accounting transactions and events to external users. Financial accounting focuses on the preparation of the
five basic financial statements, namely – statement of financial position, statement of comprehensive income,
statement of cash flows, statement of changes in equity, and notes to financial statements.

Auditing – it is said that the work of an auditor begins when the work of the accountant ends. Auditing deals
with the inspection of the financial statements, which were prepared in financial accounting, by independent
certified public accountants. The purpose of auditing is for the independent CPA (called the Auditor) to
express an opinion regarding the fairness of the presentation of financial statements. This lends credibility to
the financial statements and thus increases public and investor trust.

Bookkeeping – is a branch of accounting which is responsible in recording the financial transactions of the
business. It is the starting point of the whole accountingprocess. Bookkeeping is a mechanical task involving
the collection of basic financial data. The data are first entered in the accounting records or the books of
accounts, and then extracted, classified and summarized in the form of income statement, balance sheet and
cash flow statement. This process normally takes place once a month.

The bookkeeping procedures usually end when the basic data have been entered in the books of
accounts and the accuracy of each entry has been tested. At that stage, the accounting function takes over.
Accounting tends to be used as a generic term covering almost anything to do with the collection and use of
basic financial data. It should however, be more properly applied to the used to which the data are put once
they have been extracted from the books of accounts. Bookkeeping is a routine operation, while accounting
requires the ability to examine a problem using a both financial and non-financial data.

Management Accounting/Management Advisory Services – this branch of accounting deals with the
gathering and communication of information to be used by internal users (mainly the management). It includes
services to clients on matters of accounting, finance, business policies, organizational procedures, product
costs, distribution, and many areas regarding business. A management accountant could either be employed
by the entity availing of the service (internal) or an independent CPA (external). CPAs in this field are
commonly called management accountants, internal auditors, or management consultants.

Government accounting – this branch of accounting deals with the transactions of the national government
and its different agencies. Government accounting mainly focuses on the safekeeping of public funds and for
the purpose to which such funds are committed or devoted.

Tax accounting – this branch involves the preparation of tax returns and the rendering of tax advice to clients,
such as determination and verification of tax consequences, the effect of taxes in the business operations, tax
minimization through legal means, and the like. Take note that tax accounting is not the same as government
accounting.

Fiduciary accounting – this branch of accounting deals with the handling of different accounts managed by
an individual entrusted with the guardianship and management of property and possessions for the benefit of
another party.

Accounting systems installation – This deals with the installation of accounting procedures for the gathering
of accountable financial data and embraces the designing of accounting forms to be used in the data-
gathering process. Accounting systems is closely related to management advisory services. Succeeding in
this field nowadays requires technical knowledge and skills in information technology.