Module 2- FAR

SUBJECT FINANCIAL ACCOUNTING AND REPORTING

CHAPTER/UNIT Chapter 3 /Part 1
LESSON TITLE Accounting: The Language of Business
LESSON OBJECTIVES At the end of this module, you are expected to:
a. Discuss why accounting is considered the language of business;
b. Describe and differentiate the various accounting periods of reporting
financial statements;
c. Discuss the qualitative objective of a financial report; and
d. Differentiate the various forms of business organizations.

OVERVIEW/INTRODUCTION The business entity concept in accounting separates the owner/s from
his business and the financial statements prepared by the accountant
become the bridge of communication among them and the various users
who are interested about the economic activities of the business.

ACTIVITY Story Analysis:

You, as an accounting clerk were assigned by your department

supervisor to prepare the Schedule of Expenses as of last month to be
submitted to her on the first Friday of the current month. This schedule
will be reported by her supervisor on the 10 th of the month for their
monthly meeting.

When will you prepare the report and what will be its consequences if
you prepare the schedule on the following dates?
1. 25th day of last month.
2. 11th day of the month.
3. During the first week of the month

ANALYSIS When the business starts, it is assumed that the business will continue
to operate for an indefinite period. This is the continuity or going
concern assumption in accounting. So,
1. When do the accountants prepare the financial statement
reports?
2. How do we know that the information provided are useful?
3. What are the qualities that the financial statement should
possess?
4. What are the types of accounting information?
5. Who are the users of these types of accounting information?
6. What are the forms of business organization and their types of
activities?

ABSTRACTION The business has a continuous life of existence and considering the
length of time involved in its operations, it is not practical to let owner
wait until the business stops its operations before the owner knows the
results of operations and financial condition of the business. That is why
the life of the business is divided into equal periods and at the end of its
period financial statements are prepared by the accountant. This period
is called “Accounting Period” and this is the periodicity or time period
assumption in accounting.

This explains why financial statements are prepared and communicated

to the owner of the business or various users/decisions-makers
periodically.

Accounting periods can be:

1 Month – where financial statements are prepared at the end of every

month. We call this on a “Monthly basis”. This is the shortest accounting
period.

3 Months – where financial statements are prepared at the end of every

three months. We call this on a “Quarterly Basis”.

6 Months – where financial statements are prepared at the end of every

six months. We call this on a “Semi-annual Basis”.

12 Months – where financial statements are prepared at the end of

every twelve months. We call this on a “Yearly” or “Annual Basis”.

The owner or management has three (3) annual accounting periods to

choose from as far as periodic reporting of financial statements are
concerned, these are:

Calendar Year – accounting period will begin on January 1 and ends at

December 31 of the same year. This is the most common annual
accounting period that businesses adopts as this is the nearest
accounting period wherein business entities file their Income Tax
Returns. The business records are closed on December 31 and the
deadline for filing the tax returns is on April 15 of the next year.

There are 4 quarters (consisting of three months in each quarter) in a

calendar year.
First Quarter – covers from January 1 to March 31
Second Quarter – covers from April 1 to June 30
Third Quarter – covers from July 1 to September 30
Fourth Quarter – covers from October 1 to December 31

Fiscal Year – the accounting period will begin on the first day of any
month of the year except January and will end on the last day of the
twelfth month completing the one year period.
Example, if the period begins on May 1, 2020, it will end on April 30,
2021.
IF quarterly basis is used in reporting financial statements:
First Quarter – covers from May 1 to July 31
Second Quarter – covers from August 1 to October 31
Third Quarter – covers from November 1 to January 31
Fourth Quarter – covers from February 1 to April 30

Natural Business Year – is a twelve month period that ends on any

month when the business is at the lowest or experiencing slack season.
Example, a fiscal year for the hotel industry where the start is the point
of slack in visitors and ends up at its peak season.

An enterprise may adopt any of the preceding accounting periods. The

basic consideration in the choice of an accounting period is that the
accounting period chosen must reflective of results of “normal
operations”.

QUALITIES THAT FINANCIAL STATEMENTS SHOULD POSSESS

The new framework of accounting mentions that the financial reports to

be useful should possess the following qualities:

Understandability – financial statements should be prepared and

presented in a way that can be understood by the users. Users are
expected to study the financial information with reasonable diligence
and assumed to have reasonable knowledge of business, economics and
accounting.

However, information about complex matters which provides relevance

to the economic decision-making needs of users should not be excluded
from the financial statements on the grounds that it may be difficult for
certain users to understand.

Reliability – financial information should carry the degree of

“confidence” when used by interested parties. To be reliable, it must be
“free from material error” that will lead to material misstatement, it
must be fairly presented and must be free from bias.

The PFRSC’s new accounting framework provides’ that in order to

become reliable the financial reports should possess the following
characteristics:
a) faithful representation – the information shows what it purports
to show, means the financial statements should be adequate.
Accountants should properly report the actual events and their
respective amounts in the financial statements as objectively as
possible.
b) neutrality – financial reports should be fairly presented and must
be free from bias. It must be directed towards the common
interest of the users. It is not good to give favor to one party in
 detriment to the other.
c) conservatism – under this doctrine, when alternatives exist, the
alternative which has the least effect on owner’s equity should be
chosen. As between two honestly doubtful alternatives,
1. understatement of assets and income
2. overstatement of assets and income, the former (1) is
preferred over the latter (2). This is conservatism. It is
expressed in this manner, “anticipate no profit and provide
for all losses”. In this new accounting framework issued by
the PFRSC, this conservatism concept is called the “prudence
convention”.
d) Completeness – financial statements is said to be complete if it
contains full disclosure of significant information necessary in
order that the statement would not be misleading. Financial
Statements should also contain notes and supplementary
schedules and other information.
e) substance over form – financial accounting emphasizes the
economic substance of events even though the legal form may
differ from the economic substance and suggest different
treatment.

Relevance – this means that financial statements are prepared intended

to help users make informed economic decisions.
For example, a balance sheet is relevant in determining “financial
condition” just as the income statement is intended for measuring the
economic events and affect corrective measures in the future. The
following major ingredients describe the relevance of financial
statements:
a) materiality – there is no strict rule in determining whether an
item is material or not. Very often, this is dependent on judgment
and common sense.

In determining materiality, judgment has to be focused on:

i. Size of the item in relation to the total of the group to
which the item belongs.

ii. Size of the company in terms of total sales or capital.

iii. Nature of the item – an item may be inherently

material because by its very nature it affects economic
decision.

Materiality provides a threshold or cut-off point rather than,

primarily quantitative characteristics which an information must
have if it is to be useful.

b) predictive value – the financial information enables the users to

forecast and make predictions about the outcome of the future
 events.

c) feedback value – the financial information enables the users to

confirm past predictions about the outcome of the future events.

d) timeliness – the financial information must be available at the

time of need or else it will defeat the purpose.

Comparability – the financial statements prepared are worth comparing

for with other companies of the same line of business by pointing out
similarities and differences.

Consistency – once a method or practice is selected from alternatives, it

should be followed from period to period. The consistency of procedure
or method does not only maintain the comparability of periodic
statements but also implants reliability in the reports.

TYPES OF ECONOMIC INFORMATION

As there are many types of economic decisions, there are also many
types of accounting information. The following are among the types of
accounting information that are specialized by a professional
accountants most widely used in business community:

Financial Accounting – deals primarily with traditional recording of

financial transactions which would eventually result to the preparation
of general-purpose financial statements intended for investors,
creditors, government agencies, etc. as compared to specific purpose
financial statements which are needed by management to guide them
in the decision-making process for the company.

Auditing – are classified into two: internal and external auditing. The
internal sees to it, that the established accounting procedures are being
followed throughout the year. It determines strict adherence to
management policies and measures the efficiency of operations. These
are usually performed by its own employees or staff of the company
while external auditing is performed by an independent professional
accountant, who critically examines the book of accounts and renders an
opinion on the fairness of financial statements being examined.

Management Accounting – primarily focuses on the gathering of

financial informative data intended for use by management.
Management compares actual results of operation against the budget
and makes analysis of the variance. Variance is the difference between
actual and budget.
Tax Accounting – involves the preparation of income tax returns and the
determination of correct amount of taxes due and payable to the
government. The most challenging aspect of tax accounting is not the
preparation itself, but the tax planning which is anticipating the tax
effects of business transactions and structuring these transactions in a
manner that will minimize the income tax burden.

Financial Management – is a new type of accounting information

wherein its primary concern is to set-up financial planning objectives –
including the sources and application of its resources beneficial to the
economic entity.

Cost Accounting – is concerned primarily with gathering, accumulations

and control to determine the cost of production of goods and services
and setting-up the selling price thereafter. Cost accumulation
procedures used by manufacturing concerns are classified into job order
and process costing.

Government Accounting – deals primarily on the proper custody of

public funds in both national and local government, such as cities,
provinces, municipalities and barangays.

The Offices that are charged with accounting responsibilities are as

follows:
1. Department of Budget and Management (DBM) – this
department is responsible for the formulation and
implementation of the National Budget, efficient and sound
utilization of government funds to achieve the country’s
development objectives.
2. Bureau of Treasury (BTr) – this department receives and keeps
funds and manage and control the disbursement of funds.
3. Commission on Audit (COA) – keeps the general accounts of the
government, promulgates accounting rules and regulations and
submit to the President of the Philippines and Congress, within
the time fixed by law, an annual report of the government, its
subdivision, agencies and instrumentalities.

USERS OF FINANCIAL STATEMENTS

Financial accounting information is used by a variety of groups and

diverse purposes. The needs and expectations of users determine the
type of information required. The users of financial statements and their
information needs are as follows:

Investors – they need information to help them determine whether they

should buy, hold or sell. Shareholders are also interested in information
which enable them to assess the ability of the enterprise to pay
dividends.
Employees – are interested in information about the stability and
profitability of the enterprise. They are interested in information which
enables them to assess the ability of the enterprise to provide
remuneration, retirement benefits and employment opportunities.

Lenders – are interested in information which enable them to determine

whether their loans and interest thereon will be paid when due.

Suppliers and other trade creditors – these users are interested in

information which enable them to determine whether the amounts
owing them will be paid on maturity.

Customers – customers 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.

Government and their agencies – These users require information to

regulate the activities of the enterprise, determine taxation policies and
as a basis for national income and similar statistics.

Public – enterprises affect members of the public in a variety of ways.

For example, enterprises makes 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.

FORMS OF BUSINESS ORGANIZATION AND THEIR TYPES OF ACTIVITIES

There are four (4) forms of business that persons may choose to
organize depending upon their intention and capacity to contribute
funds for the business. They are:

1. Single or Sole Proprietorship

- the simplest form of business organization
- capital is owned and provided by one person called Proprietor
- may manage the business by himself or hire another person to do so.

Whether the business succeeds or fails, the owner has to bear it all
including any unpaid obligations that the business may have incurred.
That is the reason why the business itself does not file and pay income
tax. The net income of the business is reported in the owner’s personal
income tax return.

As there is only one owner in the sole proprietorship business, the

capital account is called “Owner’s Equity”.

2. Partnership
-formed by two (2) or more persons called “Partners”
-set forth agreements among themselves on how profits and losses are
divided.
-two or more persons may form partnership for the exercise of
profession.
-a partner may contribute personal services to the partnership.

Since partnership is merely a contract, it can be terminated anytime.

One cannot be admitted in the partnership without the consent of other
partners. As there are two or more partners, the capital account is called
“Partners Equity”.

3. Corporation
-the biggest and most complicated form of business organization
-organized by at least five (5) but not more than 15 natural persons
called “Incorporators” and
-the corporate charter is called “Article of Incorporation”
-is registered with the Securities and Exchange Commission (SEC), filed
together with by-laws.

In a Corporation, capital is called “Share Capital” which is divided into

units called “Par Value”

Two (2) classes of share capital:

1. Ordinary share or Common capital stock and
2. Preferred share

-owners of the shares of stock are called Shareholders

-ownership is evidenced by “Share Certificate”

-shares of stock can be transferred without dissolving the corporation

so it enjoys unlimited life.

-50 years is the maximum number of years that a corporation can exist,
but can be extended by amending the Article of Incorporation.
-this is the reason why there are corporations that existed for more
than 100 years.

As there are hundreds if not thousands of shareholders, the capital is

called “Shareholder’s Equity”.

4. Cooperative
-is formed by fifteen (15) or more natural persons who are Filipino
citizen, of legal age, having a common bond of interest and are actually
residing or working in the intended area of operation.

-it operates similar to corporation

-their charter called “Articles of Cooperation” is registered with

Cooperative Development Authority (CDA)

-has Board of Directors who are elected among its members

-the General Assembly shall be the highest policy-making body of the

Cooperatives; their voting share is on a one-man, one vote.

The net surplus of the cooperative will be divided by among

themselves after deducting the following statutory requirements:

10% - General Reserve Fund

10% - Cooperative Education and Training Fund
7% - Optional Fund
3% - Community Development Fund

The balance of 70% is for interest on share capital and patronage

refund which will be given during the Annual General Assembly meeting.

As there are hundreds or thousands of members in Cooperative, the

capital account is called “Member’s Equity”.

TYPES OF BUSINESS ACTIVITIES

Regardless of how the business are formed, they may again be
classified as to what type of business activities they are engage in, these
are:

Service Concern – the business derived its income from services

rendered to clients in case of professional services, like that of

Accountants
Lawyers
Doctors
Dentists, etc.,

or

to customers in the case of non-professional services, like that of

a hotel where room rental is the main line of their business

laundry shop
car repair services
janitorial services
internet café, etc.

Merchandising Concern – the business is engaged in buying goods or

commodities or any form of finished products and sells them at a profit.
- might be at a retail or wholesale basis
 - grocery stores are the best example
- also includes the food and beverage sold in restaurants and
related establishments

Manufacturing concern – the business is engaged in buying of raw

materials and supplies to be processed or manufactured, converting
them into finished products for sale at a profit, like that of
- a furniture shop
- manufacturers of cars and home appliances, etc.
- bakeries and restaurants are no exceptions

Hybrid Companies – are those involve in more than one type of activity
which are manufacturing, merchandising and service. For example,

- a hotel operating with a restaurant

Hotel industry deals with services while restaurants are a mixture of

manufacturing and merchandising.

Most of the big restaurants and hotels are operated by a corporation

and sometimes are owned by a single individual.

APPLICATION 1. Self-Check Activity

(Read and understand the reading materials in the Abstraction column.
Afterwards the teacher will provide multiple choice questions for
students to check if they understand the materials provided. Students
will know immediately their score after taking the quiz.)

ASSESSMENT 1. Self-test (quiz on line with scheduled time)

Reference(s) Financial Accounting and Recording by. R. Lopez

Basic Financial Accounting & Reporting by W. Ballada
Accounting Principles by Weygandt, Kimmel and Kieso