ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1

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Module 1
ACCOUNTING AND ITS ENVIRONMENT
Week 1

Introduction

Accounting has evolved, as in the case of medicine and law, in response to the social and
economic needs of society. As business and society become more complex, accounting develops
new concepts and techniques to meet the ever-increasing needs for financial information. Without
such information, many complex economic developments and social programs may never have
been undertaken.

In a market economy, information helps decision-makers make informed choices regarding the
allocation of scarce resources under their control. When decision-makers are able to make
wellinformed decisions, resources are allocated in a way that better meets the needs and goals
of those within the market.

Accounting is relevant in all walks of life, and it is absolutely essential in the world of business.
Accounting is the system that measures business activities, processes that information into
reports and communicates the results to decision-makers. Accounting quantifies business
communication. For this reason, accounting is called the language of business. The task of
learning accounting is very similar to the task of learning a new language; thus, the need for this
book which teachers the Basics of Accounting in a very conceptual manner.

No business could operate very long without knowing how much it was earning and how much it
was spending. Accounting provides the business with this information and more. So, accountants
can be called the scorekeepers of business. Without accounting, a business couldn’t function
optimally; it wouldn’t know where it stands financially, whether it’s making a profit or not, and it
wouldn’t know its financial situation. Also, a sound understanding of this language will bring about
a better management of the financial aspects of living. Personal financial planning, education
expenses, car amortization, business loans, income taxes and investments are based on the
information system that we call accounting.

INTENDED LEARNING OUTCOMES

After studying this module, students should be able to:
1. Define accounting and explain its role in business.
2. Explain the fundamental business model and determine how it is applied to the various
types of businesses.
3. Differentiate the forms and activities of business organizations.
4. Determine the importance of the purpose and phases of accounting.
5. Explain the fundamental accounting concepts and principle.
6. Identify the career opportunities open to accountants.

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DEFINITIONS OF ACCOUNTING
Table 1 presents the definitions of accounting and their respective references. Table

1 - Definitions of Accounting

Definition Reference

Accounting is a service activity. Its Statement of Financial Accounting Standards No.

function is to provide quantitative 1, “Basic Concepts and Accounting Principles
information primarily financial in Underlying Financial Statements of Business
nature, about economic entities that Enterprises” (Manila: Accounting Standards
is intended to be useful in making Council, 1983), par. 1
economic decisions

Accounting is an information system Statement of Financial Accounting Concepts No. 1,

that measures, processes and “Objectives of Financial Reporting by Business
communicates financial information Enterprises” (Norwalk, Conn.: Financial Accounting
about an economic entity Standards Board, 1978), par. 9

Accounting is the process of

identifying, measuring and American Accounting Association, “A Statement of
communicating economic information Basic Accounting Theory” (Evanston, III.: American
to permit informed judgments and Accounting Association, 1966), par. 1;
decisions by users of the information
Accounting Principles Board, Statement No. 4,
“Basic Concepts and Accounting Principles
Underlying Financial Statements of Business
Enterprises”(New York: AICPA, 1970), par. 40

American Institute of Certified Public Accountants,

Accounting is the art of recording, “Review and Resume”, Accounting Terminology
classifying and summarizing in a Bulletin No. 1 (New York: AICPA, 1953), par.9
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

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FUNDAMENTAL BUSINESS MODEL

● Developing a product or service that customers will pay and thus, will create a revenue
stream is necessary for a business to be successful.
○ Such can be
■ a new product or service that meets specific needs.
■ a better product or service.
■ a product or service that offers a better value proposition.
● A business requires investments to enable it to pay for the infrastructure, equipment and
personnel. A skillful combination of these elements are necessary for a business to
generate a revenue stream.

Figure 1 illustrates how a business is structured to provide a customer proposition.

Figure 1 - Fundamental Business Model

Five activities on the Fundamental Business Model:

1. Investors provide the required capital for the business. The cash investment will then be
held in a bank account.
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2. The cash invested in the business can be:

● Converted into other type of assets that will be used in the business (e.g.
equipment) or sold (e.g. inventory); or
● Spent on operating costs such as salaries, supplies, rentals and utilities.

3. Combining the business resources provides the basis for producing the products or
services.

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4. The sale of a product or service generates an asset called a receivable. Once collected
this asset will produce a cash inflow for the business.

5. If there’s an existing debt from banks, the cash inflow from collections will be used to pay
the debt providers with interest on their loans to the company. Remaining cash can be
sent back to the cycle by being converted into other assets or spent on operating costs
(back to stage 2). In the normal course of business, this whole process will earn profits on
which tax will have to be paid. Any profit after tax can continue to be reinvested in the
cycle or paid out to the owners as a “return” on their investments (withdrawals or
dividends).

The model outlines the way money flows around a business and provides the basis of accounting.
To manage a business effectively it is necessary to know how the cash has been spent and how
profitable the products or services have been to the business. The availability of this historical
information helps management to make informed judgments on how to improve the performance
of business.

TYPES OF BUSINESS

Despite the absence of variation in the fundamental business model, there are numerous ways of
applying this in providing the scope of products and services that comprise the business world.
However, the range of products and services can be synthesized into seven (7) types which are
listed below;

Table 1
Summary of Types of Business
Type Activity Structure Examples

Services Selling people’s Hiring skilled workers and selling Banking,

time their time Education
Accounting
Legal
Salon services

Trader Buying and Purchasing a range of raw Wholesaler

selling materials and finished goods, Retailer
commodities or consolidating them, enabling
products them to sell in locations within
the proximity of their customers
or for online delivery

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Manufacture Designing Buying raw materials and Vehicle Assembly
products, combining equipments and labor Construction
combining parts to convert them into finished Engineering
and components products Electricity, Water,
and assembling Food and Drink
finished goods Chemicals
Media
Pharmaceuticals
Raw Growing or Commonly purchasing blocks of Farming
materials extracting raw land and using them to create or Mining
materials produce the raw materials Oil

Infrastructure Selling the Purchasing and operating assets Transport (airport

utilization of (typically large assets); selling operator, airlines,
infrastructure occupancy or utilization often in trains, ferries, buses)
combination with services Hotels
Telecoms
Sports facilities
Property
management

Financial Receiving Accepting cash from depositors Banks

deposits, lending and paying them interest; using Microfinance
and investing the money to provide loans to institutions
money borrowers, charging them fees Investment house
and a higher rate of interest than
the depositors receive

Insurance Pooling Collecting cash from many Insurance companies

premiums of customers; investing the money
many to meet to pay the losses experienced by
claims of a few a few customers. By
understanding the risk accepted
and the likelihood of a claim,
more premium income can be
earned than claims paid.
FORMS OF BUSINESS ORGANIZATIONS

The types of businesses mentioned above may be performed by any of the forms of organization,
be it a single or sole proprietorship, a partnership or a corporation. The accounting procedures to
be followed will depend on the form of organization.

Sole Proprietorship

● It has a single owner known as the proprietor who usually is also the manager.

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● This form tends to be small-service-type like those of physicians, lawyers and accountants
forming their own business and retail establishments.
● All profits go to the owner. However, the owner also absorbs all losses and the only one
responsible for all liabilities of the organization.
● This form of organization is distinct from its owner or proprietor in terms of accounting
viewpoint. In relation to this, their accounting records do not include the owner or
proprietor’s personal financial records.

Partnership

● As defined in Philippine Civil Code, Article 1767, it is a contract whereby two or more
persons bind themselves to contribute money, property, or industry to a common fund,
with the intention of dividing the profits among themselves.”
● Partners in this form of organization are personally liable for any obligations incurred by
the partnership.
● Partnership is considered as a separate organization which is distinct from the personal
affairs of each partner in accounting point of view.

Corporation

● As defined in the Revised Corporation Code of the Philippines (RA 11232), it 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.” ● A form of business
organization owned by its shareholders.

Since the corporation is a separate legal entity, the stockholders are not personally liable for the
corporation’s obligations.

ACTIVITIES IN BUSINESS ORGANIZATIONS

The discussion that will follow focuses on the three types of organizational activities:

Financing Activities

● These are the methods an organization uses to obtain financial resources from financial
markets and how it manages these resources. These resources are needed to acquire
other resources used in producing goods and services.
● Primary sources of financing
○ Owners
○ Creditors like banks and suppliers
● The following are some of the financing activities:
○ Initial and additional investments
○ Repaying the creditors
○ Paying a return to the owners

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● Financial resources derived from financing activities are utilized by the organization to
acquire other resources necessary in the transformation process, that is from one form to
a different form. It can serve the needs and demands of the customers. Having the right
mix of resources is essential to efficient and effective operations.

Investing Activities

● These activities involve the selection and management including disposal and
replacement of long-term resources that will be used to develop, produce, and sell goods
and services.
● Some of the activities involve are the following:
○ buying land, equipment, buildings and other resources that are needed in the
operation of the business, and
○ selling these resources when they are no longer needed.
Operating Activities

● These activities involve the use of resources to design, produce, distribute, and market
goods and services.
● Specifically, the following are the common activities in this area:
○ research and development,
○ design and engineering,
○ purchasing,
○ human resources,
○ production,
○ distribution,
○ marketing and selling, and ○
servicing.
● Business organizations compete both in searching for the best suppliers and labor
providers as well as meeting the demand of their target markets.

PURPOSE AND PHASES OF ACCOUNTING

Accounting function handles not only the financial operations but also provides information and
advice to other departments of the organization. It does not operate in isolation. In fact, the
accounting function is just a part of the broader business system.

A significant function of accounting is to record historical events that affect the resources of the
organization. These historical events are the business transactions that represent the economic
activities of a business. Accounts are produced to aid management in planning, control and
decision-making and to comply with regulations.

● Recording is not the first step in accounting. Before recording the effects of transactions,
it must first be measured. Accounting information will be useful if such will be expressed
in terms of a common financial denominator - money. Money serves as both a measure of
value and a medium of exchange.

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○ Several considerations need to be decided before measuring a business transaction
■ Recognition Issue - when the transaction occurred
■ Valuation Issue - what value to place on the transaction
■ Classification issue - how the components of the transaction should be classified

● To maximize the benefit out of the financial information, it is not enough to just simply
measure and record the transactions. It must be classified and summarized for such to be
useful in making decisions. The effects of numerous transactions are categorized into
useful groups or categories. This phase is known as classification.

● Summarization of financial data is achieved through financial statements preparation.

This phase summarizes the effects of all business transactions that occurred during a
particular period.

● The last phase in accounting which is interpretation or analysis of financial information

will be performed after going through the summarization phases. The results are
interpreted or analyzed to evaluate the financial position and performance of the
organization through financial ratios such as liquidity, profitability and solvency. .
Accounting provides the decision-makers with information to make reasoned choices
among alternative uses of scarce resources in the conduct of business and economic
activities.

FUNDAMENTAL CONCEPTS
In recording business transactions, accountants should consider the following fundamental
concepts that underlie the accounting process.

Fundamental Explanation
Concept

Entity Concept ● An accounting entity is an organization or a section of an organization

that stands apart from other organizations and individuals as a
separate economic unit.
● This concept states that the transactions of different businesses or
entities should not be accounted for together. Even businesses of
one single proprietor need to be accounted for separately.
● Each entity should be evaluated separately.

Periodicity Concept ● This concept allows users to acquire timely information that will
serve as a basis on arriving at economic decisions about future
activities.
● An entity’s life can be meaningfully subdivident into equal time
intervals for reporting purposes. Waiting for the actual last day of
operations will not be necessary to perfectly measure the entity’s
profit.
● The common accounting period for the purpose of reporting
externally is one year.

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Stable Monetary ● This concept is the basis for ignoring the effects of inflation in the
Unit Concept accounting records of the organization.
● A reasonable unit of measure that is considered in accounting is the
Philippine Peso. Its purchasing power is assumed to be relatively
stable meaning it allows accountants to add and subtract peso
amounts as though each peso has the same purchasing power as
any other peso at any time.

Going Concern
● This concept pertains to the preparation of financial statements
considering the assumption that the reporting entity is a going
concern and will continue in operation for the foreseeable future.
● With this concept, it is assumed that the entity has neither the
intention nor the need to enter liquidation or to cease operations.
● This concept underlies the depreciation of assets over their useful
lives.
CRITERIA FOR GENERAL ACCEPTANCE OF AN ACCOUNTING PRINCIPLE

Certain guidelines need to be followed in accounting practice. Generally accepted accounting

principles (GAAP).encompass the conventions, rules and procedures necessary to define
accepted accounting practice at a particular time.

Accounting principles

● Established by humans
●
● Evolving, not eternal truths
● General acceptance usually depends on how well it meets three criteria
○ Relevance- extent to which the resulting information is meaningful and useful to
those who need to know something about a certain business.
○ Objectivity - extent to which the resulting information is not influenced by the
personal bias or judgment of those who furnish it. It connotes reliability and
trustworthiness. It also connotes verifiability, which pertains to determining
whether the information provided is correct.
○ Feasibility - extent to which it can be implemented without undue complexity or cost.
These criteria often conflict with one another. In some cases, the most relevant
solution may be the least objective and the least feasible.

BASIC PRINCIPLES

In order to generate information that is useful to the users of financial statements, accountants
rely upon the following principles:

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Objectivity Principle

● Accounting records and statements are based on the most reliable data available so that
they will be as accurate and as useful as possible.
● Reliable data are verifiable when they can be confirmed by independent observers. Ideally,
accounting records are based on information that flows from activities documented by
objective evidence.
● Without this principle, accounting records would be based on whims and opinions and is
therefore subject to disputes.

Historical Cost

● This principle states that acquired assets should be recorded at their actual cost and not at
what management thinks they are worth as at reporting date.

Revenue Recognition Principle

● Under this principle, revenue is to be recognized in the accounting period when goods are
delivered or services are rendered or performed. This is regardless of whether there is an
actual collection on the date of sale.

Expense Recognition Principle.

● Expenses should be recognized in the accounting period in which goods and services are
used up or incurred to produce revenue and not when the entity pays for those goods and
services.

Adequate Disclosure

● Under this principle, it requires all relevant information that would affect the user’s
understanding and assessment of the accounting entity to be disclosed in the financial
statement.

Materiality

● Under this principle, financial reporting is only concerned with information that is significant
enough to affect evaluations and decisions.
● Materiality depends on the size and nature of the item judged in the particular
circumstances of its omission.

Consistency Principle

● The firms should use the same accounting method from period to period to achieve
comparability over time within a single enterprise. However, changes are permitted if
justifiable and disclosed in the financial statements.

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THE ACCOUNTANCY PROFESSION

Characteristics

Accountancy qualifies as a profession because it possesses the following attributes:

● All members of the accountancy profession are Certified Public Accountants, which means
that they have earned a Bachelor of Science in Accountancy degree and have passed the
CPA Licensure Examinations.
● CPAs have their own body of language. They use terminology peculiar to the profession
(e.g. debits and credits).
● CPAs adhere to a Code of Ethics. This code upholds the CPA’s responsibility to serve the
public with competence and integrity. The public, in return, expresses its confidence to
CPAs by relying on the financial statements they audit.
● Like other professions, CPAs are members of a national organization, the PICPA, whose
role is to ensure the continued improvement of the accountancy profession to meet the
demands of the times.

Career Opportunities

The professional accountant is presented with diverse opportunities. The demand for accounting
services has increased with the increase in number, size, and complexity of business. The
accountant may be engaged in any of the following areas of competence:

Public Practice

● This pertains to those accountants who render services on a fee basis and staff
accountants employed by them.
● Public accountants, who practice individually or as members of public accounting firms,
should be certified public accountants (CPAs).
● Their work includes auditing, taxation and management advisory services.
● Firms vary greatly in size. Some are small proprietorship and others are large
partnerships. There are large global CPA firms with more than 1,000 partners.
● Largest accounting firms (in alphabetical order) in the United States:
○ Deloitte & Touche,
○ Ernst & Young,
○ KPMG, and
○ PriceWaterhouseCoopers.
○ Arthur Andersen & Co. is now history;
■ The firm used to be the biggest but succumbed to pressures brought about
by a lot of financial fiascos including that of Enron, Sunbeam, Waste
management and WorldCom.
■ These firms employ only about 12 percent of the CPAs in the United States
but they audit the financial statements of approximately 85 percent of the
top corporations.

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● Biggest firms In the Philippines,
○ Sycip Gorres Velayo & Co. (SGV & Co. )
■ with over 1,800 professionals from various disciplines.
■ SGV & Co. is a member practice of Ernst & Young Global.
○ Punongbayan & Araullo,
○ Laya Mananghaya & Co.,
○ C.L. Manabat & Co.,
○ Isla, Lipana & Co. (Joaquin Cunanan & Co.),
○ Constantino, Guadalquiver & Co.,
○ Carlos J. Valdez & Co.,
○ Alba Romeo & Co.,
○ Diaz Murillo Dalupan & Co. and
○ Reyes Tacandong & Co. among others.
● The top partners in these large accounting firms earn about the same amount as the top
executives of other large businesses. Public accounting is the frequently traveled career
path because it offers excellent opportunities to gain multi-faceted business experience.
● Sample Entry level jobs:
○ Audit staff
○ Tax Staff
○ Management Services/Consulting Manager
● Advanced positions: ○ Partner
○ Senior Partner
○ Senior Consultant/Financial Advisor.

Commerce and Industry

● Accountants employed in this area vary widely in their scope of activities and responsibilities.
● Sample Entry-level jobs:
○ Financial Accounting and ○ Financial Analyst, Reporting Staff, ○
Budget Analyst,
○ Management Accounting Staff, ○ Credit Analyst,
○ Tax Accounting Staff, ○ Cost Accountant;
○ Internal Audit Staff, ●
Middle-level positions:
○ Comptroller, ○ Senior Fraud Examiner,
○ Senior Information Systems ○ Senior Forensic Auditor
Auditor,
● Advanced positions:
○ Chief Financial Officer ○ Chief Information Officer.

Government Service
● Accountants may be hired by the following:
○ Congress of the Philippines,
○ Commission on Audit (COA),
○ Bureau of Internal Revenue (BIR),

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○ Department of Finance,
○ Department of Budget and Management,
○ Bangko Sentral ng Pilipinas (BSP) and
○ the local government units (e.g. provincial, city or municipal governments).
● Sample Entry-level jobs
○ State Accounting Examiner ○ Audit Examiner ○ State Accountant
○ Budget Analyst
○ LGU Accountant ○ Financial Services Specialist
○ Revenue Officer
● Middle-level positions
○ State Accountant V
○ Director III and Director IV, Government Accountancy and Audit
○ Financial Services Manager
○ Audit Services Manager
○ Senior Auditor
● Advanced positions
○ National Treasurer
○ Vice President for Finance/ CFO (for GOCC’s)
○ Commissioner
○ Associate Commissioner
○ Assistant Commissioner, (COA/ BIR, BOC).

Education/ Academe
● This area guarantees the continued development of the profession by endeavoring to
clarify and address emerging issues through research and sharing the results obtained
with their colleagues.
● Considered as modern day heroes, they make others understand the body of accounting
knowledge.
● In addition, they painstakingly prepare candidates for the tough CPA exams. With the
advent of information technology, this sector is being challenged to focus accounting
education from the “transfer of knowledge” approach to the more-effective “learning to
learn” approach.
● Sample Entry-level jobs
○ Junior Accounting Instructor
● Middle-level positions
○ Senior Faculty
○ Accounting Department Chair
● Advanced positions
○ Vice President for Academic Affairs
○ Dean.

BRANCHES OF ACCOUNTING

The main branches of accounting and their brief description are discussed as follows:
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Auditing

● accountancy profession’s most significant service to the public.

○ An external audit
■ the independent examination that ensures the fairness and reliability of the reports
that management submits to users outside the business entity.
■ The result of the examinations is embodied in the independent auditor’s report.
■ Once the required financial statements have been prepared by management, they
have to be evaluated in order to ensure that they do not present a distorted
picture.
■ External auditors
● appointed from outside the organization.
● job is to protect the interests of the users of the financial statements.
○ Internal auditors
■ By contrast to external auditors, they are employees of the company.
■ They are appointed by, and answer to the companies management though
they work independently of the accounting and other departments.
■ They ensure the accuracy of business records, uncover internal control
problems and identify operational difficulties.
○ To differentiate further, internal auditors perform routine tasks and undertake detailed
checking of the company’s accounting procedures, whereas external auditors are
likely to go in for much more selective testing.
○ Nonetheless, they usually work very closely together, although the distinction made
between them still remains important.

Bookkeeping

● a mechanical task involving the collection of basic financial data.

● The data are first entered in the accounting records of the books of accounts, and then
extracted, classified and summarized in the form of income statement, balance sheet and
cash flow statement.
○ An income statement shows whether the business has made a profit or loss during
the period, i.e. it measures how well the business has done.
○ A balance sheet lists what the entity owns (its assets), and what it owes (its
liabilities) as at the end of the period.
○ The cash flows statement presents the cash inflows and outflows of the business
during the period.
○ 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 the
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.

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● Bookkeeping is a routine operation, while accounting requires the ability to examine a
problem using both financial and non-financial data.

Cost Bookkeeping, Costing and Cost Accounting

Cost bookkeeping
● the process that involves the recording of cost data in books of accounts.
● similar to bookkeeping except that data are recorded in very much greater detail.
● Cost accounting makes use of those data once they have been extracted from the cost
books in providing information for managerial planning and control.

The difference between bookkeeping per se and cost bookkeeping is largely one of degree of
detail.

Cost accounting
● cost accounting system contains a great deal more data, and thus once the data are
summarized there is much more information available to the management of the
company.
● deals with the collection, allocation, and control of the cost of producing specific goods
and services. This accumulation and explanation of actual and prospective cost data is
important to control current operations and to plan for the future.
● one of the main sub-branches of management accounting.

Financial Accounting
● Focused on the recording of business transactions and the periodic preparation of reports
on financial position and results of operations.
● Financial accountants accord importance to generally accepted accounting principles.
● More specific term applied to the preparation and subsequent publication of highly
summarized financial information.
● The information supplied is usually for the benefit of the owners of an entity, but it can also
be used by management for planning and control purposes. It will also be of interest to
other parties, e.g., employees and creditors.

Financial Management
● a relatively new branch of accounting that has grown rapidly over the last 30 years.
● Financial managers
○ responsible for setting financial objectives, making plans based on those objectives,
obtaining the finance needed to achieve the plans, and generally safeguarding all
the financial resources of the entity.
○ much more heavily involved in the management of the entity than is generally the
case with either financial or management accountants
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○ draws on a much wider range of disciplines and relies more extensively on
nonfinancial data than does the more traditional accountant.

Management Accounting
● Incorporates cost accounting data and adapts them for specific decisions which
management may be called upon to make
● A management accounting system incorporates all types of financial and non-financial
information from a wide range of sources.

Taxation
● includes the preparation of tax returns and the consideration of the tax consequences of
proposed business transactions or alternative courses of action.
● Accountants with this specialization aim to comply with existing tax statutes but are also in
constant legal search for ways to minimize tax payments.
● If tax experts attempt to reduce their clients’ tax liabilities strictly in accordance with the
law, this is known as “tax avoidance”.
○ Tax avoidance is a perfectly legitimate exercise,
○ Tax evasion (the non-declaration of sources of income on which tax might be due) is
a very serious offense.

Government Accounting
● It is concerned with the identification of the sources and uses of resources consistent with
the provisions of city, municipal, provincial and national laws.
● The government collects and spends a huge amount of public funds annually so it is
necessary that there is proper custody and disposition of these funds.

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