Fundamentals of ABM 1

CHAPTER 1
LESSON 1
A NUMBERS GAME
There are numerous successful businesses both locally and internationally. Some top-
of-mind companies include Microsoft, Apple, Coca-Cola, and Procter & Gamble. Here in the
Philippines, surging businesses include Puregold, Petron, Globe, and many others.
These businesses offer products that are distinct from one another. Have you ever
wondered about the secret formula for a company's success? This discussion can go on and
on for days without yielding a definite answer. Nonetheless, there is a common factor among
these businesses that contribute to their success— accounting.
Accounting involves the processes of identifying, recording, and communicating

financial information to internal and external users alike. It helps quantify data for easier
interpretation. Numbers are the language of business. To efficiently manage your business,
you need to know numbers. After gathering the data on the performance of the company,
these are summarized and used as a guide for future decision-making. Accounting is a tool
used in achieving all these goals.
How will the manager know if the company is doing well? How can he/she know if
additional investment is needed in a particular segment of the company? If not for
accounting, managers will still be making decisions not based on a solid foundation.
Accounting is, broadly speaking, a system that helps businesses track events that affect
them. This process involves identifying the events that affect a business, recording these events,
and communicating the summarized results of all events within a particular period to interested
parties.
Almost all companies allot a significant amount of resources to the accounting process
since it aids them in improving their business. For example, the sale of Toyota cars is identified as
an economic event that affects the company. The accountant will record this transaction and
consolidate all records by the end of the month. The consolidated records can be used by the
top management to identify potential problems encountered by the company. This can also
be used to attract potential investors. The accounting process is very beneficial to a company.
We will further emphasize this point in the next chapters.
THE ACCOUNTING PROCESS

The starting point of the accounting process is the identification of economic events
relevant to a business.
Examples of relevant economic events are the sale of Toyota cars (as mentioned),
provision of services by a hospital, payment to suppliers, and purchase of equipment for the
manufacturing of Bench shirts. To be identified as a relevant economic event, there should be
a transfer of things with value. Normally, for the purchase of equipment, cash or money is
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This module is exclusive to Mother Theresa Colegio Group of Schools students only.
exchanged for the equipment. The cash and equipment both have value making the purchase
a relevant economic event. This analysis is also applicable to the other examples given.
The recording of relevant economic events is the next step in the accounting process,
after a company identifies the relevant economic events, it records those events which will serve
as the history of its financial activities. Recording events should be done systematically and
chronologically for easier tracking and interpretation. Records of events are inputted in the so-
called accounting books.
Finally, after a lapse of a specific period (usually one year), companies summarize all the
recorded economic events into accounting reports. The most popular accounting reports are
the financial statements. All similar events during the period are lumped together to provide
meaningful and presentable information. As such, all sales transactions during the period are:
NATURE OF ACCOUNTING
The basic features of accounting are as follows:
1. Accounting is a process. A process is composed of multiple steps that lead to a common end
goal. The enrollment process in your school may involve reservation of slots, filling out
documents, attending school orientations, and payment of necessary fees. These steps all lead
to you being enrolled in your school. Likewise, accounting is a process because it performs the
functions of identifying, recording, and communicating economic events with the end goal of
providing information to internal and external parties.
2. Accounting is an art. Art refers to a way of performing something. It entails creativity and skills
to help us attain some objectives. Accounting is the art of recording, classifying, summarizing,
and finalizing financial data. Accounting is a combination of techniques and its application
requires applied skill and expertise. This is the reason why accounting can be considered as an
art. (Accountingtheory.com)
3. Accounting deals with financial information and transactions. Accounting deals only with
quantifiable financial transactions. These are the only events identified by the accountant,
recorded in the books, and communicated to different parties. Nonfinancial transactions are
not the focus of the accounting process. However, nonfinancial data may be used to interpret
and better estimate some financial data.
4. Accounting is a means and not an end. As mentioned earlier, accounting is a tool to achieve
specific objectives. It is not the objective itself. Imagine that you dream to go to Paris someday.
Accounting can be thought of as the plane that will bring you to your destination.
5. Accounting is an information system. Accounting is recognized and characterized as a

storehouse of information. As a service function, it collects processes and communicates
financial information of any entity. This discipline of knowledge has been evolved out to meet
the need for financial information required by different interested groups.
(Accountingtheory.com)
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FUNCTIONS OF ACCOUNTING
The American Accounting Association (AAA)
 Defines accounting as "the process of identifying, measuring, and communicating
economic information to permit informed judgments and decisions by the users of
information."
American Institute of Certified Public Accountants (AICPA)
 Defines accounting as "the art of recording, classifying, and summarizing in a
significant manner and terms of money, transactions, and events which are in part
at least of a financial character and interpreting the results thereof."
The main functions of accounting can be summarized as follows:

1. Keeping a systematic record of business transactions
2. Protecting properties of the business
3. Communicating results to various parties in or connected with the business
4. Meeting legal requirements 5.
Keeping Systematic Record of Business Transactions
Recording transactions does not only involve entering the transactions in the accounting
books. The records should be systematic enough to enable an easy understanding of readers.
No matter how comprehensive the records are, if they are not produced systematically, then
they provide little to no value.
Protecting Properties of the Business
The accounting records serve as the evidence that properties of a business do exist or
how much of a particular resource does a company has. If the accounting records show that
the amount of cash should be PI 000 000, any excess and deficiency will be noticed
immediately. Moreover, the accounting system helps in preventing employee fraud and
misappropriation of company resources.
Communicating Results to Various Parties in or Connected with the Business
The accounting reports produced at the end of each period are not only used by
external parties (e.g., potential investors, government agencies), but also by the management
in their decision-making function. Communication of the results of operations of a company is
essential for all concerned parties to enable them to take well-informed decisions.
Meeting Legal Requirements
In the Philippines, the government requires some companies (particularly those with public
accountability) to provide financial reports quarterly, semi-annually, or annually. This procedure
aims to protect the public by providing them with the necessary information to make sound
decisions. The government also requires reports from heavily regulated industries such as the
energy and oil industries.
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HISTORY OF ACCOUNTING
It is believed that the history of accounting is thousands of years old and can even be
traced to ancient civilizations. A number of history books suggest that the early development of
accounting can be dated back to ancient Mesopotamia. During those times, people followed
a system of writing and counting money. The development of accounting may be related to
the taxation and trading activities of temples.
The reign of Emperor Augustus (63BC—14AD) provided more evidence about the
development of accounting. The Roman government kept detailed financial information f the
deeds of Emperor Augustus regarding the stewardship of Roman resources. This is evidenced by
the Res Gestae Divi Augusti (The Deeds of the Divine Augustus). The Roman historians Suetonius
and Cassius Dio recorded that in 23BC, Augustus prepared a rationarium (account) which listed
public revenues, the amounts of cash in the aerarium (treasury), in the provincial fisci (tax
officials), and in the hands of the publicani (public contractors); and that it included the names
of the freedmen and slaves from whom a detailed account could be obtained. The closeness
of this information to the executive authority of the emperor is attested by Tacitus' statement
that it was written out by Augustus himself. (Oldroyd 1995)
Many consider the dissemination of the double-entry bookkeeping of Luca Pacioli in

fourteenth-century Italy as the most important event in accounting history. Luca Pacioli is
acknowledged as the father of modern accounting because of this. The double-entry
bookkeeping system is defined as any bookkeeping system that has a debit and a credit for
each transaction. Luca Pacioli's Summa de Arithmetica, Geometria, Proportioni et
Proportionalita (Review of Arithmetic, Geometry, Ratio, and Proportion) is the first book printed
with a treatise on bookkeeping. The double-entry bookkeeping system is the system being used
to this very day. (Sangster et al. 2007)
The modern profession of the chartered accountant originated in Scotland in the

nineteenth century when Queen Victoria granted a royal charter to the Institute of Accountants
in Glasgow. At present times, accounting standards are already available to guide accountants
in their practice of the profession. Some of these standards include the PFRS (Philippine Financial
Reporting Standard) and the PAS (Philippine Accounting Standards).
ACTIVITY 1.1
1. Describe and explain the nature of accounting
2. Explain the functions of accounting in business
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3. Do you think that non-financial information is still useful in the accounting process?
Explain and justify your answer.
4. Give a concrete example of how you can use accounting in your daily life.
References
http://www.accountingtheory.com/nature-and-scope-of-accounting.html. Retrieved on Dec.

15, 2015.
Oldroyd, David. "The Role of Accounting in Public Expenditure and Monetary Policy in the First
Century AD Roman Empire." Accounting Historians Journal, Vol. 22, Number 2. Birmingham,
Alabama. December 1995.
Sangster, Alan, Greg Stoner, and Patricia McCarthy. 2007. The Market for Luca Pacioli's Summa
Arithmetica. Cardiff.
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CHAPTER 2 BRANCHES OF ACCOUNTING
LESSON 2 THE STORY OF NUMBERS
What do you usually picture in your mind when you hear the words investigation,
crime, or evidence? You probably see images from popular criminal dramas such as Sherlock
Holmes. These programs typically present a crime scene that the main character tries to solve.
Investigators use fingerprints, bloodstains, DNA samples, and other clues to find the criminal. We
are easily hooked with these kinds of shows because we feel that we are part of the team solving
the case. We, more often than not, derive joy from solving mysteries.
But did you know that such mystery-solving activities can also involve accounting?
That's right! A field of accounting called forensic accounting deals with activities that solve
cases of theft and fraud. Forensic accounting combines accounting, auditing, and investigative
skills in conducting investigations. Unlike the crime dramas that focus on murders, forensic
accounting is used to study the numbers of a company to find any inconsistency and to unearth
the wrongdoings of company employees.
In 2001, the fall of Enron, a large American energy company, sent shockwaves to
the financial markets around the world. In a gist, the company's misrepresentation of its earnings
and its modification of its balance sheet to show favorable performance led to its downfall and
subsequent bankruptcy. Forensic accounting played a role in understanding the causes of
Enron's demise.
Accounting is a broad field of study. It ranges from the usual recording of

company transactions to the case-solving activities mentioned in this featured story. In the
discussion in this chapter, you will learn that accounting has more to offer.
In this chapter, we will tackle the different branches of accounting and the
different services provided by these branches. There are eight branches of accounting as
follows:
1. Financial accounting
2. Management accounting
3. Government accounting
4. Auditing
5. Tax accounting
6. Cost accounting
7. Accounting education
8. Accounting research
Each branch has its own functions and use. We will discuss these branches one by one.
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FINANCIAL ACCOUNTING
Financial accounting is a branch of accounting primarily handling the recording of

financial transactions of a business. The financial transactions are later summarized into
standardized accounting reports, more popularly known as the financial statements, for the
benefit of internal and external users.
Financial statements should provide information useful to a wide range of users in their
economic decisions. This is the main reason why accounting standards such as the Philippine
Financial Reporting Standard (PFRS) and the Philippine Accounting Standards (PAS) are
created. The PFRS and PAS supply guidelines on how companies should prepare their financial
statements. Standardized financial statements allow the users to compare the results of
operations of different companies regardless of size and nature.
Imagine a person, Aira, who plans to invest her savings in Petron, Shell, or Chevron. Before
she makes her decision, it is only rational for her to compare the three oil companies and see
which one will most likely be the most profitable investment. Even if Petron, Shell, and Chevron
belong to the same industry, different presentations of the companies' financial statements will
make it hard for Aira to choose which company she would invest in. A standardized way of
presenting financial statements enhances the comparability of different companies.
Likewise, standardized financial statements are also useful for creditors. Besides
enhancing comparability, standardized financial reports improve the understandability of the
company's financial statements. Creditors will be able to assess the riskiness of a company
through the well-presented financial statements.
As stated above, financial accounting caters to the need of both internal and external
users. However, financial accounting's main goal is to provide the information needs of external
users that cannot request information directly from management.
GENERAL PURPOSE FINANCIAL STATEMENT

Are the financial statements prepared to accommodate the information needs of
persons who cannot request or acquire the information directly from the company?
If the answer is yes, the financial statements are called general purpose financial
statements. Otherwise, the financial statements are called special purpose financial statements.
Primary Users of General Purpose Financial Primary Users of Special Purpose Financial
Statements Statements
 Investors
 Creditors  Top management (ex., Board of
 Shareholders/Stockholders directors of a company, CEO,
 Government Agencies CFO, COO)
 Auditors  Department managers (ex. Sales
 Other interested outside parties manager, production manager)
 Other internal parties
Predominantly, external parties use general purpose financial statements to evaluate the
performance of the company. On the other hand, specific purpose financial statements are
utilized by internal parties to guide them in the decision-making process for the company.
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MANAGEMENT ACCOUNTING
Management accounting is a branch of accounting that focuses on the preparation of

financial reports used by managers in their day-to-day decision-making. Reports generated
using management accounting are for internal users only. As such, management reports need
not follow accounting standards such as the PFRS and PAS. Additionally, unlike financial reports
that are generated quarterly, semi-annually, or annually, management reports can be done
daily, weekly, or whenever managers require a specific report. Management reports typically
contain information regarding the amount of cash on hand, the level of sales revenue for a
particular period, costs incurred, or even the comparison of actual results with budgeted
amounts.
Aside from the frequency and the intended users of reports, management accounting differs
from financial accounting like information produced. Financial accounting summarizes financial
information gathered within a specified period. Thus, financial accounting provides historical
information. Meanwhile, management accounting information is forward-looking. It contains
forecasted information used by managers in planning.
ROLE OF MANAGEMENT ACCOUNTANTS
According to the Chartered Institute of Management Accountants (CIMA), chartered

management accountants perform the following roles:
 Advise managers about the financial implications of projects

 Explain the financial consequences of business decisions
 Formulate business strategy
 Monitor spending and financial control
 Conduct internal business audits
 Explain the impact of the competitive landscape
 Bring a high level of professionalism and integrity to the business
It is emphasized that management accounting is used in deciding how the business

should act going forward. The use of management accounting provides value to the business
since it assists the company in selecting only those activities that deliver benefits more than the
related costs.
MANAGEMENT ACCOUNTING SKILL SET
In addition to strong accounting fundamentals, management accountants should also

possess the following strategic business and management skills:
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 Analysis. Management accountants should be able to analyze information and use it to
make business decisions.
 Strategy. Management accountants should be able to formulate business strategies that
will increase the company's wealth and create value for the company's shareholders.
 Risk. Management accountants should be able to identify risks that can potentially have
detrimental effects on the company. At the same time, management accountants
should give recommendations on how to manage such risks.
 Planning. Management accountants should be able to apply accounting techniques in
the planning and budget creation phase of a business.
 Communication. Management accountants should be able to identify what information

the management needs and also explain the numbers to nonfinancial managers.
ETHICAL CODE
Even though management reports do not follow the requirements imposed by accounting
standards like the PFRS and PAS, management accountants are still expected to follow the
CIMA code of ethics.
GOVERNMENT ACCOUNTING
According to Section 109 of the Presidential Decree government accounting is defined

as an accounting system that "encompasses the process of analyzing, recording classifying,
summarizing, and communicating all transactions involving the receipt disposition of
government fund and property and interpreting the result thereof!'
Section 110 of the same decree lays down the objectives of government accounting:
1. To provide information concerning past operations and present conditions

2. To provide a basis for guidance for future operations
3. To provide for control of the acts of public bodies and offices in the receipt, disposition,
and utilization of funds and property
4. To report on the financial position and the results of operations of government agencies
for the information and guidance of all persons concerned
Government accounting is used by all government agencies (e.g., DepEd, OPWH, and
BIR). Due to the specialized nature of government transactions, stricter controls should be
put in place to prevent the misuse of the country's resources. The creation of the New
Government Accounting System (NGAS) aims to address this concern.
NEW GOVERNMENT ACCOUNTING SYSTEM (NGAS)

As citizens of the Philippines, we are very much concerned about the stewardship of the
government of public resources. We do not want the country's funds to be used for persona!
reasons by erring public officials. Instead, we want these funds to be used for public projects
that will benefit many constituents.
One of the main features of the NGAS is that it enhances responsibility accounting in all
agencies. Simply stated, responsibility accounting relates financial results to a particular
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responsibility center (i.e., agency). If there is a problem with the handling of funds by the DPWH,
for example, people in that agency will be the ones accountable. This system of placing
accountability in each agency discourages misappropriation and misuse of public funds.
GOVERNMENT ACCOUNTING PROCESS

Government accounting starts after the declaration of the General Appropriations Act
(GAA). The GAA is the enacted budget of the country for the upcoming year. The GAA has the
force of law and it states how much an agency can spend for the year. If it is indicated that
P500M is available for the DPWH to implement its projects, the agency cannot spend more than
this amount.
The government accounting process involves the Commission on Audit (COA), the
Department of Budget and Management (DBM), the Bureau of Treasury (BTr), and all other
government agencies.
The COA is responsible for the keeping of the government's general accounts. Think of
our government as one big, non-profit organization. The COA is tasked to keep and update the
accounting books of the whole organization. Moreover, the COA disseminates accounting rules
and regulations to be used by all agencies.
In accordance with Section 2, Chapter 1, Title XVII, Book IV of the Administrative Code the
Philippines, "The Department of8udget and Management shall be responsible for the
formulation and implementation of the National Budget to attain our national socio-economic
plans and objectives. The Department shall be responsible for the efficient and sound utilization
of government funds and revenues to effectively achieve the country's development
objectives."
The BTr is responsible for the safekeeping of the national funds. It serves like a bank where
the funds are kept. Although its main role is the safekeeping of funds, the BTr is also responsible
for the management and control of the disbursements of such funds. Furthermore, the agency
is also responsible for maintaining accounts of financial transactions of all-natural government
agencies
AUDITING
Financial statements prepared by a company are often the only source of information
an interested outside party has regarding the results of the company's operations. The
information included in the financial statements greatly influences the decisions made by the
users. Because of this, there seems to be a conflict of interest between the users and the source
of the financial statements.
The users of the financial statements want information about the company that is truthful,
reliable, and relevant. In making their economic decisions, users want to use information that
depicts the current condition of the company. On the other hand, management (or any other
party preparing the financial statements) usually wants to present information indicating good
results. Some managers will even falsify or manipulate the records of financial transactions just
to show decent results. This is exactly what happened in Enron as featured in our featured story.
With the users' need for truthful, reliable, and relevant information and the management's
tendency to manipulate results, how do financial statements provide value to interested
parties? The answer is auditing.
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Auditing is an unbiased examination and evaluation of the financial statements of an
organization (Investopedia.com). Auditing is a process that includes numerous steps to
determine whether or not a company's financial statements are presented truthfully.
Accountants that perform the auditing procedure are specifically called auditors. Auditors,
aside from having the competence to perform their roles, should also be independent of the
company being audited. Independent auditors have no connection with the company. If an
employee of the company is the one who examines and evaluates the financial statements,
the fear of the users that the results are manipulated will not be alleviated.
An audit of the financial statements improves their credibility. Financial statements that
underwent the process of auditing are called audited financial statements. A set of financial
statements will only be useful to users after it has gone through the process of auditing. Audited
financial statements are accompanied by the auditor's opinion. The auditor's opinion will be the
basis of whether or not the financial statements are prepared truthfully and without any material
errors.
TAX ACCOUNTING
Taxes are the lifeblood of the government. Without the taxes the citizens pay, the
government cannot perform its functions. Thus, it is imperative that the collection of taxes be
unhindered.
The recording of financial transactions mentioned in Chapter 1 follows specific guidelines
provided by the PFRS and PAS. Tax accounting records some financial transactions differently.
It adheres to some guidelines in the PFRS and PAS, but it is not required to implement everything
written in such standards. Tax accounting follows the pronouncements of the National Internal
Revenue Code (NIRC). The NIRC is to tax accounting as the PFRS and PAS are to financial
accounting.
To illustrate the difference, let us look at a particular example. Starbucks offers its
customers a card that they can use to pay for their orders. The process is simple. You ask the
cashier to load the card; you pay for the amount of load, and then your card will reflect the
balance available for you to use. You can use the card for future transactions with Starbucks.
Under the PFRS and PAS, Starbucks will not recognize the amount you paid as revenue until you
use the balance on your card in the future. Under the NIRC, Starbucks recognizes the revenue
when the company received the payment from you. Thus, if Starbucks recognizes the revenue,
it is taxable.
There are still many differences between tax accounting (N IRC) and financial
accounting (PFRS and PAS). The discussion of such differences is not within the scope of this
book. What is important to note is that tax accounting enables the taxing authorities to collect
taxes that differ from the amount due computed using the financial accounting standards.
Another key difference lies in the type of report generated. Financial accounting generates
reports known as financial statements while tax accounting produces tax returns to be filed to
the appropriate government aåencies.
COST ACCOUNTING
Cost accounting is a branch of accounting that provides information for management

accounting and financial accounting (Horngren et al. 201 1). For example, cost accounting
helps measure the cost of a bicycle fora bicycle-selling company. This information supports
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management in deciding how many bicycles to produce, the selling price of the bicycle, or
valuing the inventory of bicycles in the company's financial statements.
TERMS USED IN COST ACCOUNTING

These are just some of the terms used in cost accounting. For this book, you only need
to understand these basic cost concepts. The application of cost accounting is not within the
scope of this book.
Cost - the resource sacrificed to achieve an objective (e.g., money, resources, time, etc.)
 Cost object anything that you wish to find the cost of (e.g., cost of a pair of jeans, cost of
a pair of Jordan Xl shoes)
 Cost driver - an activity that is a cause of the incurrence of costs (e.g., the number of
working hours is related to the number of salaries a company pays)
 Direct cost -- costs that can economically be traced to a cost object (e.g., materials,
labor, etc.)
 Indirect cost — costs that cannot be traced to a cost object (e.g., costs of supplies used
in the factory, the salary of supervisor overseeing factory operations, etc.)
 Fixed cost — costs that do not change within a relevant range of activity (e.g., rent of a
factory building, insurance costs, etc.)'
 Variable cost — costs that change as the level of activity or production increases (e.g.,
materials cost, labor cost, selling cost, etc.)
ACCOUNTING EDUCATION
The Bachelor of Science in Accountancy (BSA) in the Philippines is normally a 5-year

program composed of subjects in accounting, audit, administration, and business laws and
taxation. Although the subjects usually highlight the business environment, the scope of the
topics in BSA also covers other fields such as banking and finance, government, nonprofit
organizations, and the academe. Students of the course are also trained to create and
understand computerized accounting systems to cope with the rapidly changing technology.
Most schools use a combination of diverse teaching techniques to explain
accountancy to students. Some of these methods are classroom discussions, case analysis,
individual and group reporting, feasibility studies, and lectures from renowned individuals in the
field. Other schools require students to undergo an internship program equivalent to one
subject. This is to enable the students to have a feel of the application of accounting in real life.
ADMISSION REQUIREMENT FOR BSA
According to the Commission on Higher Education (CHED), the standards of admission

to any BSA program should be sufficiently rigorous and demanding. Only universities which can
demonstrate the capability to teach accountancy at a sufficiently high level are allowed to do
so. Requirements at each school are different, but the common requirements include:
 Must be a high school graduate
 Must have a college entrance examination of above average or depending on the
specific rating set by the school
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 Aside from the college entrance examination, must pass the separate aptitude test
specific for BS in Accountancy
 Must pass the interview conducted by the college admission officer
 Some schools require a high school QPA of 85% and above with no grade less than 80%
in all subjects.
 Some schools require students to have an 85% or higher average rating in the National
Secondary Assessment Test (NSAT).
 As set by CHED, all schools must conduct an English Proficiency examination for all BS in
Accountancy applicants.
 Admission for Philippine Educational Placement Test (PEPT) passers mainly depends on
the school's discretion since some colleges and universities offer only selected courses.
BOARD EXAM
Before a BSA graduate can practice accountancy, he/she needs to pass the Certified
Public Accountant Licensure Examination. The CPA Licensure Exam is a comprehensive test
composed of seven subjects. Each subject will be taken within 3 hours so the exam will be for 21
hours all in all. A candidate should achieve a general average of at least 75% with no rating
below 60% in any of the seven subjects to pass the exam.
ACCOUNTING RESEARCH
Accounting research, as the name suggests, is a branch of accounting that deals with
the creation of new knowledge. Combining the models produced by the hard sciences in
research and testing with financial statements, stock prices, surveys, and experiments, we can
gain a specific perspective and basis on the following:
 Deciding and implementing new accounting and auditing standards

 Presenting unusual economic transactions in the financial statements
 Learning how new tax laws impact clients and employers
 Discerning how the accounting profession affects the capital markets through academic
accounting research
Researchers in the accounting field also apply the scientific method like their counterparts in
the sciences. With the constantly evolving field of accountancy, it is expected that accounting
research will continue to play a vital role in the future.
ACTIVITY 1.2
1. What are the similarities and differences of financial accounting

and management accounting?
2. Differentiate general-purpose financial statements from special-purpose financial

statements.
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3. Explain how management accounting helps managers in their day-to-day decision-making.
4. How does management accounting provide value to the business?
5. What are the roles of a management accountant?
6. What is the skill set required to be possessed by a management accountant?
References
•“Audit” Investopedia.com.http://www.investopedia.com/terms/a/audit.asp.Retrieved on
December 15, 2015.
•BS Accountancy in the Philippines. http://www.finduniversity.ph/majors/bs-in- accountancy-

phillipines/.Retrieved on December 15, 2015.
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CHAPTER 3 USERS OF ACCOUNTING INFORMATION
LESSON 3 Rags to Riches
SM might just be the most recognizable two-letter combination here in the

Philippines. If you think about it, it is amazing how these two letters tell a rich history. SM is an
avenue for almost anything you desire to do. From family gatherings, meetings with friends, or
simply enjoying some alone time for yourself, SM truly "got it all for you."
SM is no exception to the struggles faced by all start-up businesses. SM was
founded as a shoe store by Henry Sy, Sr, in October 1958 in downtown Manila. During those
times, the company catered to a relatively small customer base. Mr. Sy thought of establishing
a shoe store with a store layout and merchandising concepts never before seen in the
Philippines. The popular shoebox structure of its malls became the trademark of SM. From its
humble beginnings in Manila, SM is currently a retail giant.
The success and expansion of SM are partnered with a growing customer
base. Additionally, investors are more interested in investing in the company to share in its
success. Creditors are now more willing to lend to the company since they are assured that it
can pay. Being a large player in the economy, SM is also closely watched by government
agencies.
In the past, SM need not produce financial reports to cater to the information
needs of interested parties. Nowadays, it is beneficial for both the company and outside parties
if SM provides such information needs.
In this chapter, we will discuss the different users of accounting data. As you will know, reports
are not only for interested outside parties but internal parties as well.
To be successful, businesses must interact with countless customers, investors
creditors, and other groups. No known business is established just to transact with itself. These
outside parties are the main sources of income and/or funds that are key factors in determining
if a business will be profitable or not. Given the importance of building lasting relationships with
these groups, how can a business continue to capture the interest of such groups?
The communication of accounting information is one answer to this problem.
By communicating the accounting information to these different parties, they are empowered
to make better economic decisions. Financial reports supply the information these groups
demand them to make decisions connected to the business. However, it is a common
misconception that the users of accounting information include only outside parties. This is not
the case. Employees of the company, especially managers, also use accounting information to
make well-informed business decisions. After all, the success of a business is also heavily
dependent on the people running it.
As mentioned in the previous chapters, companies typically produce two
types of financial statements (i.e., general-purpose financial statements and special purpose
financial statements). General-purpose financial statements are intended to provide
information to those who cannot request directly from the company. Some examples of such
groups are customers, creditors, potential investors, and government agencies. Imagine the
workload if all of these groups can just demand financial reports at will. It is not wise for a
15
company to produce financial reports that cater to each specific need of these user groups.
This is. why general purpose financial statements should contain information that can answer
the inquiries of a wide range of interested users.
On the other hand, special purpose financial statements are usually produced
based on the requests of parties that can ask for accounting information directly from the
company. Some examples of such groups are the board of directors, managers, employees,
and the stockholders or owners (existing investors).
This distinction resulted in the broad groups of users of financial information: external users and
internal users. In the following sections, we will discuss and differentiate these two broad groups.
We will also give some examples of the people belonging to each group.
EXTERNAL USER
COSTUMER
As much as human beings need oxygen to live, a business needs customers to survive.
Customers are the main source of income for businesses. It can even be claimed that most
businesses are established solely for the service of their customers. Businesses usually aim to
widen their reach by targeting multiple customers segments. All of us have been a customer at
some point in our lives. When you buy shampoo in the nearby sari-sari store, you are considered
a customer. When you have your hair cut by the local barber, you are considered a customer.
When your household avails the services of Maynilad or Meralco, you are considered a
customer. It is important to point out, however, that even large businesses can be customers.
For example, most restaurants do not raise livestock for their use.
Instead, they purchase chicken, beef, pork, and other livestock products from their trusted
suppliers. In this sense, these businesses are customers themselves. Simply put, customers are
people or entities that acquire goods and services for a fee.
Customers are one user group that is particularly interested in the accounting information
of a business. By analyzing the accounting information of a business, customers can determine
if it will be profitable for them to transact with the business. This is especially essential if the
customer plans to build a long-term relationship with the business. Let us go back to the
restaurant example mentioned above, If a supplier is having financial difficulties or has a track
record of being unreliable, restaurants will probably not ask for its services. Financial reports also
hint at the quality of products and services the business offers. If a company is continuously
showing losses in its financial statements, it might indicate that the products and services
provided by the company are not of high quality. Customers will most likely veer away from this
company. Another thing customers look for in the company's financial report is its capabilities
to honor obligations (e.g., warranties and aftersales services).
Normally, customers note the income of a company. The income is a good indicator of
the profitability of a company. A profitable result of operations is a signal that the customers will
take minimal risk if they decide to deal with the company. Occasionally, customers also try to
16
know the future commitments of the company (e.g., plans for expansion of the business or to
discontinue a business segment) since it will affect their long-term plans as well.
Illustrative example:
Patricia plans to organize a furniture shop. She wants her business to take off by building
the furniture from scratch. However, the materials needed to build the furniture will be
purchased from an outside supplier. Patricia has two possible suppliers: Dayana Company and
Dray Company. For the last 5 years, Dayana Co. and Dray Co. displayed positive income in their
financial statements with Dray Co. having a slightly higher income on average than Dayana
Co.'s. Both companies are regarded as reliable suppliers. But during the last year, Dray Co.
experienced problems in its operations due to a labor strike preventing it from fulfilling all orders.
What company should Patricia choose as her supplier?
Based on the facts given, Patricia should choose Dayana Co. as her supplier. Even
though Dray Co.'s income is slightly higher on average than Dayana Co.'s, the reliability of
Dayana Co. is the more important factor to consider. Since the operation of Dayana Co. is
stable, it will likely be the more stable supplier.
CREDITORS
Most large businesses (sometimes, even small businesses) require additional funds to
operate business. In the early phase of a business, the contribution of the owners or investors is
the fuel that drives the company forward. When the fuel runs out, the business must find a new
source of funds. Possible sources of additional funds are the creditors. Creditors lend their
resources (usually money) to the business in exchange for a fee. The fee charged by creditors is
the payment for the use of their resources. As you probably learn in economics, money loses its
value over time. The value of PI 000 today is not equal to the value of PI 000 one year from now.
This is the main reason why creditors ask for a fee, usually in the form of interest, when you use
their money. Common examples of creditors are banks, lending institutions, wealthy individuals,
and even the government.
Before creditors grant loans to a business, they first examine its financial statements. The
biggest fear of creditors is that they will not get paid the amount due to them. No matter how
high the interest rates creditors charge, it will not matter if they cannot claim it in the end. This is
the main reason why creditors take a close look at a company's financial statements. If a
company exhibits stable income and consistently desirable results, creditors are inclined to lend.
Meanwhile, if a company is in dire financial conditions, creditors will think twice before lending.
Generally, creditors would not lend to a risky company. However, some creditors still offer their
money to these companies in exchange for higher interest rates or lending fees. As a rule of
thumb in the field of finance, "high risk, high returns”.
Similar to customers, creditors ordinarily observe the profits of a company. Creditors are
concerned with the profits of the company because the profits will be the funds available to
17
repay them. If a company's profits are consistently high, creditors will feel more secure that the
company will not default on its debts. Aside from the level of profits, creditors also look at the
number of borrowings the company has. Having high profits is not much of an upside if the
company still has huge amounts of debts. For example, if the profits of a company for 2014
totaled ₱2M and its demandable debt amounts to ₱3M, there is still a chance that a creditor
will not get paid.
Three main factors considered by creditors before lending to a company:
1. Riskiness of lending
2. Profitability of the company
3. Company's amount of borrowings
Amadeo Co., textile manufacture, submitted a proposal to Philippine Rural Bank (PRB)
which states that the company plans to borrow P5M payable 2 years from now. Amadeo Co.
also promises to pay interest of PI 50 000 every six months. PRB examined Amadeo Co.'s financial
statements. Based on the bank's analysis, they formed the following conclusions:
1. The profit of Amadeo Co. grew by an average of 10% each year for the past 3 years.
2. Amadeo Co. only has a small number of borrowings.
3. Amadeo Co. never defaulted on its borrowings in the past.
Assuming no other use for its excess funds, should PRB lend money to Amadeo Co.? The
answer is yes. The conclusions showed that lending to Amadeo Co. is not a risky endeavor.
POTENTIAL INVESTORS
In some ways, potential investors are comparable to creditors. Continuing the analogy in
the last section, investors may also provide the additional fuel to drive the company forward.
Investors put their resources (usually money) in a business hoping to earn a decent amount of
return. Unlike creditors who are assured to earn the interest and fees, investors may win or lose
in their investment. Investing in a business is a gamble.
To compensate investors for the risks they take, they normally could earn more profits
than creditors. Creditors earn a fixed amount of profits in the resources they lend (i.e., interest
and fees). Investors, on the other hand, enjoy no limit on the number of profits they can receive.
If the company you invest in is doing well, expect a large amount of profit. If the company you
invest in incurs a loss, you might even lose everything you invested. Everyone can be an investor
as long as you have enough resources to place in the company's stewardship. Investors are
mostly wealthy individuals, but businesses can invest in other businesses as well.
Financial statements provide potential investors with the necessary information to decide
if they will invest in the business. Investors are even more afraid than creditors of the possibility
that they will lose their money. If a company becomes insolvent (i.e., assets are less than the
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liabilities), creditors are paid first before the investors. Through the company's financial
statements, investors try to estimate the risk associated with investing in the company. Moreover,
investors seek companies that can give them a decent return on their investments.
This does not mean that investors invest only in non-risky companies. Some individuals
invest in risky companies. An example of such a company is a startup company. If their gamble
is successful, individuals who invest in such companies will earn higher rates of return.
The level of profits presented in the financial statements is a primary concern for investors.
This information is a key indicator if an investment will be profitable. Investors also evaluate the
company's financial ratios (you will learn these ratios in finance or higher accounting subjects)
to get a feel of how the company operates. Investors look out for the earnings retention policy
of a company as well.
Aryana is a successful career woman. During her 15-year tenure as an engineer, she
amassed a total of ₱I 0M in savings. Instead of placing her money in the bank, which earns only
2% in interest every year, she plans to invest in either Shell or Petron. Shell and Petron are two of
the largest oil companies in the country. After analyzing the financial statements of both
companies, Aryana noted that Petron and Shell earned high levels of profit for the past 2 years
with Petron garnering ₱40M more in profits. In addition, Petron is planning to expand the business
which is expected to bring in more profits for the company.
Based on the facts given, it is more probable that an investment in Petron will be a more
profitable investment in the long run. As illustrated in this example, both the company and the
investor will benefit from the communication of accounting information. Investors can make
better-informed decisions while companies can attract potential investors to provide additional
funds.
GOVERNMENT
The government is likewise a user of a company's financial statements. Does the

government plan to invest or Iend money to businesses? It is a possibility, but the main purpose
of the government is to regulate the business in the economy, our economy consists of
thousands of businesses interacting with one another. The government's main role is to scrutinize
businesses, especially the large ones. Different government agencies are assigned to check if
businesses follow guidelines provided by law in their operations. Government agencies also see
if businesses are not trying to deceive the other users of financial statements by misrepresenting
the number of earnings or manipulating portions of the company's financial statements.
Regulating businesses is a crucial role to prevent financial collapse like what happened in the
United States (and in other countries as well) during the Enron bankruptcy.
The government, particularly the taxing authorities, also uses financial statements to
compute the amount of taxes payable by a company. Companies' desire to pay lower taxes
19
might encourage them to understate revenues and overstate expenses to the detriment of the
public. Taxing authorities guarantee that this wrongdoing does not occur.
The government particularly looks at the income, revenues, and expenses of a company.
Officials want to ensure that companies do not overstate their income to attract more investors
and creditors. Investing huge amounts of money in a company with lower than perceived value
can be very harmful to the economy. Revenues and expenses are closely scanned for tax
purposes:
The Bureau of Internal Revenue (BIR) is responsible for the assessment and collection of
taxes from its constituents. As you probably heard in the news, BIR is strengthening its collection
policies to provide more funds for the government to use. In the BIR, tax assessors and tax
collectors study the financial statements of the companies and compare them with filed tax
returns. If the tax returns do not match the results of the financial statements, the BIR computes
for the appropriate taxes to be collected.
ACADEME
Members of the academe (e.g., professors, researchers, students) benefit from the
accounting information in the financial statements of a company. Although they do not usually
transact with businesses, members of the academe utilize financial statements for academic
purposes. The use of financial statements for academic purposes is not confined to the
accountancy field. Other fields of study like banking and finance, entrepreneurship, and
economics similarly make use of financial statements.
As early as Chapter 1, it is already stated that the financial statements tell a story about
the operations of a company. Professors and students take advantage of this fact. For example,
if a class plans to study the footwear industry, they might want to look at the financial statements
of footwear companies like Adidas and Nike. By doing so, professors and students might get an
idea of how the industry operates. Financial statements also serve as a blueprint to help students
in understanding the field of accountancy. Most textbooks contain samples of financial
statements. A student of accountancy is exposed to numerous financial statements of
companies belonging to different industries.
Alternatively, researchers study financial statements to identify particular trends in a

specific industry or the economy as a whole. The result of the studies conducted by researchers
can greatly help the government in assessing the condition of the economy. Researchers may
also aim to improve the accountancy practice in the country by searching for loopholes and
possible improvements in the accounting standards currently being used.
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Zed is currently enrolled in a BSA program in the Philippines. For his project, he was tasked
to report on the condition of the consumer goods industry in the country. He must also explain
how the businesses in the industry operate.
To accomplish his project, Zed can take a look at the financial statements of some
businesses like Procter & Gamble and Unilever. Being the top two businesses in the industry, the
performances of P&G and Unilever are a good indicator of the condition of the industry. The
nature of the operations of these businesses can also be seen in their financial statements.
PUBLIC
The general public is the last group considered to be an external user, why does the
general public concern themselves with the condition of a company even though they do not
have any plans to deal with said company? What are the benefits derived by the general public
in the financial statements of a company? We will answer these questions shortly.
Companies undoubtedly affect the whole economy. By continuing to operate,

companies create jobs for the public. The results of company operations also pull the economy
toward growth or recession. Financial statements give us hints about the condition of the
economy. If the economy is not doing well, the general public cut on their spending and
increase their savings. The contrary is true. if the economy is prosperous. By analyzing the
financial statements of companies, the public can properly respond to the various economic
cycles.
The public's behavior concerning their levels of consumption and spending is not the only
thing affected when they study financial statements. Since financial statements taken together
can represent the economy, other decisions of the public that can be affected involve:
1. Whether or not it is wise to start a business given the current economic conditions;
2. To stay on your current job or look for a higher-paying job;
3. Determining the best use of a person's resources (i.e., where to put your money); and
4. Determining the optimal level of savings and consumption.
This list is not exclusive. There are still many decisions that can be affected when a person
studies the financial statements of companies. What is being emphasized here is the effect of
accounting information provided in the financial statements to the general public.
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INTERNAL USER
MANAGEMENT
Accounting information is processed into summarized financial statements not only for
the benefit of external parties. People inside the company are interested users as well.
Management is composed of employees within the company that can implement

decisions affecting the company's operations. Members of the board of directors, top
management, middle-level managers, and supervisors are the common classes of employees
belonging to the management group. From here on out, we will collectively refer to them as
"managers." The key distinction between managers and other employees is the managers,
authority to make judgments for the company. Managers often function as the brain of the
company. Thus, information about company operations is often given to them.
All managers must know the company inside and out. By examining financial statements,
managers can identify problems and respond to them accordingly. Some problems faced by
managers include, but are not limited to the following:
1. What areas of the business are becoming problematic?

2. What segments of the business underperformed during the last period? What is the
cause of such underperformance?
3. Is the level of company expenses becoming alarming?
4. How does the company handle its debt? Is the company incurring too much borrowing
that will be difficult to pay in the long run?
5. Does the company use its resources in the best possible way?
These are just some of the questions that can be answered when managers study
financial statements. Likewise, managers also discover the strong points of the business. If a
manager sees that the business is performing well in a particular segment, he or she may further
devote the company's resources to this profitable segment. The benefits provided by
accounting information to managers are seemingly unlimited.
Fix-It Beauty Salon is one of the largest and most successful salons in the country.
For the past 5 years, Fix It earned significant amounts of profits. Financial statements from the
previous year indicated a net income of PI 0M. During the first quarter of the ensuing year,
revenues of the company are well below budgeted amounts. The first quarter's poor
performance alarmed the owners, so they asked Mr. Louie Tan, head of company operations,
to identify and solve the problem.
By examining the financial statements, Mr. Tan noticed that 10 out of 25 branches of Fix-
It had revenues below the budget. He also noticed that the marketing and advertising expenses
of these branches were also materially below the budget. He found out that managers of these
branches cut on the advertising expense in hopes of improving the net income figure. This plan
22
backfired since revenues lost are greater than the savings from marketing and advertising. Mr.
Tan immediately ordered the managers of these branches to follow the proposed advertising
expense in the next quarter.
EMPLOYEES
Some employees of a business, aside from managers, sometimes take a look at the
company's financial statements. Unlike managers who examine the financial statements to
make better decisions for the benefit of the company, these employees use financial
statements primarily for personal reasons.
Employees are concerned with the company's profitability. If the company they are
working for is profitable, employees feel that they will timely and adequately receive their
compensation and additional benefits. Additional benefits include year-end bonuses, fringe
benefits (e.g., medical insurance, transportation allowances), remuneration packages, and
termination pay. The current condition of a company also impacts employee morale and
performance. Companies that are performing well almost always have employees that are
motivated. On the other hand, employee demotivation might be the effect of not meeting
company goals.
OWNERS OR STOCKHOLDERS
Owners or stockholders are the existing investors of the company. They are to be
distinguished from the potential investors discussed earlier in the chapter. Owners or
stockholders already invest their resources in the company. In other words, they have already
taken the gamble. Some owners or stockholders take an active role in the management of the
business while others just wait for the generation of profits. Whatever their role in the business
might be, all owners or stockholders are interested in the results of company operations.
Predominantly, owners or stockholders want to know if their investments will yield

acceptable returns. A profitable business keeps its investors happy. As a result, investors would
not liquidate their ownership. They might even provide additional resources while the business is
enjoying success. Meanwhile, businesses that fail to achieve desired profit levels usually result in
dissatisfied owners or stockholders.
ACTIVITY 1.3
I. Classify each of the following as either external user (E) or internal user (I).
1. Academe
2. Creditor
3. Customer
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4. Employees
5. General Public
6. Government
7. Management
8. Owners or Stockholders
9. Potential Investors
II. Review Questions
1. Who are the external users of accounting information? Explain the specific needs of
each type of external user.
2. In your point of view, which external user benefits the most from accounting
information? Explain.
3. How can the operations of a company affect the general public? Is the effect on the
general public direct or indirect? Explain.
References
Joselito G. Florendo, copyright 2016, Fundamentals of Accountancy, Business, and

Management 1, Pages 35-43.
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CHAPTER 4 FORMS OF BUSINESS ORGANIZATION
LESSON 4 RUNNING THEIR WAY TO THE TOP
by Jerry Weygandt, Paul Kimmel, and Don Kieso
What well-known US company started almost 40 years ago with a waffle iron? It is
recognized by its trademark Swoosh logo and popular company motto, "Just do it." That's right,
Nike. Who would have thought that what started as a food business will become one of the
most successful shoe companies in the world?
Nike was co-founded by Bill Bowerman and Phil Knight, a member of Bowerman's track
team in the University of Oregon. Both guys began venturing into the shoe industry as early as
the 1960s. At that time, Bowerman was making handcrafted running shoes for his university track
team. Knight imported low-cost, high-quality shoes from Japan for eventual resale. In 1964, the
two formed Blue Ribbon Sports, a partnership that marketed Japanese shoes.
It was not until 1971 that the company started making its line of shoes. Along with the
new shoes came a new company name—Nike. From a partnership called Blue Ribbon Sports,
the company changed its business organization into a corporation. In 1980, Nike issued its first
stock to the public. Stock ownership plans were also granted to employees, giving them the
opportunity in the company success. Since then, Nike has been enjoying remarkable growth
with 2009 sales reaching $19.2 billion.
Nike is not alone in the shoe industry. Its main competitor, Adidas, battles Nike for the
number one spot in the shoe industry. As you will learn in this chapter, there are many forms of
business organization that a company can be. Each form has its advantages and
disadvantages. Some forms are not available to specific businesses because of legal restrictions.
We will study each form of business organization one by one.
Businesses are organizations commonly made to earn profit. Throughout its life, a
company deals with multiple groups of individuals to achieve its end goal of profit generation.
Nonetheless, there are organizations established not for the pursuit of profit. These are not-for-
profit organizations which include charitable institutions, public hospitals, public schools, etc.
There are four forms of business organizations available to aspiring businessmen— sole
proprietorship, Partnership, corporation, and cooperative. Each form has its advantages and
disadvantages. Aspiring businessmen take these into considerations before deciding what form
their businesses will take. However, some types of businesses are not permitted to use some form
of business organization. For example, businesses formed by individuals for the practice of their
profession are not allowed to be corporations. We will see the reason behind it as the chapter
progresses.
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SOLE PROPRIETORSHIP
Sole proprietorships, as the name suggests, are businesses formed by a single

individual. A sole proprietorship is considered the simplest form under which a business can
operate. Unlike partnerships and corporations, businesses operating as sole proprietorships do
not have separate legal existence from the owner. The law does not recognize a sole
proprietorship as a separate juridical entity distinct from the owner. As such, the owner usually
transacts with other parties under his or her name.
Even though sole proprietorships do not have separate legal existence, owners can
opt to operate the business under their names or use fictitious names such as Aling Nene Sari-
Sari Store. Fictitious names merely trade names that aim to instill brand recall to customers. Thus,
fictitious names do not, in any way, result in a separate juridical personality for the business.
Being indistinguishable from the owner, a business operating as a sole proprietorship

enters into contracts under the owner's name. Sole proprietorships can also sue and be sued
under the owner's name. Many businesses start as sole proprietorships before transforming into
partnerships or corporations. A sole proprietorship has its share of advantages and
disadvantages that a person should take into account.
Advantages of Sole Proprietorships
1. Ease of formation
Sole proprietorships are much easier to establish than other forms of business
organizations. A sole proprietorship does not have to go through a rigid registration process
before it can operate. Here in the Philippines, sole proprietorships can register in the local
municipal hall. Business permits and other licenses can also be acquired from such places. The
whole process is easy and inexpensive, and it normally spans for only a short amount of time. In
addition, sole proprietorships can be formulated even with small amounts of capital. Carinderias
and sari-sari stores are prevalent businesses operating as sole proprietorships which do not
require huge amounts of investments.
2. The owner has full control of the business

Being a sole proprietorship, the owner can single-handedly decide on matters about
the business. Unlike partnerships and corporations that regularly hold meetings to make
company decisions, sole proprietors can easily make decisions to solve problems faced by the
business. The importance of fast decision-making is emphasized when problems warrant
immediate action. Furthermore, having only a single owner, a sole proprietorship does not
experience internal conflict regarding business decisions. Internal conflict can be a harmful
business. In the worst-case scenario, it can even be the cause of the downfall of the business.
3. Owners can mix personal and business assets

Owners may freely mix their assets with business assets since sole Pr0prietorships are
not separate juridical entities distinct from the owners. Partnerships and corporations do not
have this advantage. If a business is experiencing financial difficulties, a sole proprietor may use
26
personal assets to help the business recover, This is not the case for partnerships and corporations
since additional investments of owners in such corporations alter their profit-sharing structures.
4. Owners have all the profits for themselves

All the profits generated by a business operating as a sole proprietorship belong to
the owner. The determination of profit-sharing schemes is often a problem encountered by other
forms of business organization. Sole proprietorships do not need to worry about such things.
Simple taxation
The profits of a sole proprietorship are considered the income of the owner. Thus, the owner
needs only to declare the income of the business in his or her tax return and it will be taxed
accordingly.
Disadvantages of a Sole Proprietorships
1. Unlimited liability
An owner of a sole proprietorship is personally liable for all the debts incurred by the
business since a sole proprietorship has no separate legal existence distinct from the owner. The
owner and the sole proprietorship are treated as one. Unlimited liability means that creditors,
customers, the government, and other outside parties can go after the personal assets of the
owner even after extinguishing all the assets of the business in the satisfaction of their claims. This
is a huge risk that sole proprietors face. The law does not protect the personal assets of the
owner unlike in corporations.
Imagine a scenario where a sole proprietorship incurs huge amounts of debt in

connection with the operation of the business. The sole proprietorship, even if it is currently
experiencing financial difficulties, is still required to pay the obligations that become due. If the
sole proprietorship is unable to pay its obligations when they come due, creditors and other
outside parties may claim the assets of the business as payment through court proceedings.
When the assets of the business exceed the number of debts, the personal assets of the sole
proprietor will remain untouched. In this case, the sole proprietor only loses his or her investment
in the business. What is alarming for sole proprietors is when the business assets are not sufficient
to satisfy all claims. In this case, the personal assets of the sole proprietor can be used to pay for
the debts. The sole proprietor will not only lose his or her investment in the business; he or she
may lose all personal assets as well.
2. Difficulty of raising additional capital

As mentioned, sole proprietorships are characterized by having only one owner. The
initial investment of the owner is the capital of the business. When all of the initial investments
are used up, the owner is the only person that can provide additional capital. A sole
proprietorship cannot sell interest (i.e., ownership rights) in the business. Doing so would defeat
the purpose of being a sole proprietorship, In case a sole proprietor does not have enough
resources to use as capital, the only remedy available to the business is to look for creditors
willing to lend additional funds.
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3. Owner's bias
Only the sole proprietor has the authority to make decisions for the business. When
deciding how the company will move forward, the owner always has the final word. This can
be detrimental to the business especially when the owner's bias prevails and he or she does not
make rational decisions. Other forms of business organizations that have multiple owners do not
usually have this problem. Biases do not usually prevail in the other forms of business
organizations since many owners decide.
Moreover, having more decision-makers is equivalent to having more minds to think

of ideas on how to improve the business or how to solve problems encountered by the business.
The workload of a sole proprietor is also much heavier than the owners of other forms of business
organizations.
4. Partnerships are the common form of business organization used by companies who generate
profits by the practice of a profession (e.g., law firms, auditing firms).
GENERAL FEATURES OF A PARTNERSHIP
1. Separate legal existence

A partnership can also be defined as an artificial being created by the operation of law.
This results in partnerships having juridical personalities separate and distinct from their owners
(called partners). Being an artificial person, a partnership can perform the acts that the partners
can do except those acts that are purely personal. Some examples of these acts are voting in
elections and holding positions in public office.
Unlike a sole proprietorship that transacts with other parties under the name of the owner,
a partnership can enter into contracts under its name. A partnership can also acquire property
under its name. Property acquired by the partnership belongs to the partnership not to the
individual partners. However, even if a partnership has a separate legal existence, its income is
not taxed as a separate entity. After the income has been distributed to the partners, it will be
included in their respective tax returns and it will be taxed accordingly.
2. Mutual agency
Partners, being co-owners of the business, can perform acts for the partnership even
without asking permission from other partners. Mutual agency means that the acts of a partner
are binding on a partnership even though he or she has no authority to do so as long as the act
concerns the normal business operations of the partnership. The following example will further
illustrate this point.
Andre, Bart, and Charles formed a partnership called ABC Partnership. ABC Partnership
is engaged in the business of manufacturing clothes. The three partners divided the tasks in
operating the partnership among them. Andre, being a graduate with a degree in human
resource management, was designated to handle anything employee-related.
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Last week, Andre bought 10 sewing machines from DEF Company. Andre exceeded the
authority given to him since he was not assigned to purchase equipment for the company. Is
the act of Andre binding on the partnership? The answer is yes. Sewing machines are normally
used by businesses engaged in the manufacturing of clothes. Even though Andre has no
authority to perform the act, the act itself is related to normal business operations. Suppose
Andre purchased instead a brand new speedboat using the partnership's asset. In this case, the
partnership is not liable since the act has no relation to the partnership operations. Andre is the
only one liable and he should give back the partnership assets he used to purchase the
speedboat.
3. Unlimited liability
Even though a partnership has a separate legal existence, partners are still liable for debts
and obligations that cannot be paid by partnership assets. Like in a sole proprietorship, creditors
and other parties can go after the personal assets of the partners when partnership assets are
not enough to satisfy their claims. Creditors can claim the deficiency from any of the partners
or all the partners. In the ABC Partnership, if it has debt that is not paid by the partnership assets,
creditors can go after the personal assets of Andre, Bart, and Charles. Creditors can require a
particular partner to pay the whole amount of debt. If, for example, Andre paid the whole
amount of the partnership's debt not paid by partnership assets, Bart and Charles are required
to reimburse him for their proportionate share in the debt.
4. Limited life
The life of a partnership can be easily ended through partnership dissolution or liquidation.
Partnership dissolution occurs when one of the partners withdraws from the partnership or if a
new partner is admitted. Dissolution occurs when there is a change in the relationship among
the partners. The dissolution of a partnership does not necessarily mean that the partnership will
cease to exist. Withdrawal and admission of partners are normal occurrences in a partnership,
and they only lead to the formation of a new partnership.
Partnership liquidation, on the other hand, ends the operations of the partnership. During
liquidation, partnership assets are sold, liabilities are paid, and the remaining assets are
distributed to the partners. Liquidation ends the life of the partnership.
5. Co-ownership of partnership property

In the formation of a partnership, partners contribute money, property, and industry into
a common fund. Once a partner has contributed his or her money and/ or property, it does not
belong to him or her anymore. The contributed money and property belong to the partnership
and the partners only have a proportionate share of partnership assets.
In the ABC Partnership, assume that Bart contributed a delivery van valued at P500 000.
Bart cannot subsequently claim that he is the owner of the van. From the moment he
contributed the delivery van to the partnership, he only has a proportionate share of the asset.
Andre, Bart, and Charles became co-owners of the van.
Profits (or losses) of the partnership do not also belong to a specific partner. All partners
have a claim on a definite portion of the profits. The distribution of the profits should follow a
29
profit-sharing scheme agreed upon during the formation of the partnership. If there is no profit-
sharing scheme, profits (or losses) are distributed according to the original capital contributions
of the partners.
6. Partnership Agreement
The definition provided by the law states that a partnership is a contract. Contracts are
perfected through an oral or written agreement. Thus, a partnership can be formed orally or in
written form. However, to protect the interests of all partners, it is ideal to form a partnership in a
written contract. This written contract is called the articles o partnership, and it contains the
following information:
a. Name of the partnership

b. Location of the principal office of the partnership
c. The names, citizenship, and residence of the partners
d. Term for which the partnership is to exist
e. The purposes for which the partnership is formed
f. Original capital contributions of the partners
g. Profit and loss sharing agreement among the partners
The articles of partnership may also contain stipulations about admission and withdrawal of
partners, death of a partner, and partnership liquidation. The articles of partnership should try to
anticipate all situations that a partnership may encounter.
Advantages and Disadvantages of a General Partnership
Advantages Disadvantages
 Easier to create than a  Unlimited liability

corporation
 Better ability to acquire  Mutual agency
additional capital than sole
proprietorships  Limited life
 A large pool of human capital
than sole proprietorships
OTHER FORMS OF PARTNERSHIPS
The partnership we have just discussed is called a general or regular partnership. Because
of the unlimited liability characteristic of a general partnership, individuals planning to work
together sometimes use other forms of partnership. These are the limited partnership, limited
liability partnership, and limited liability company.
30
Limited Partnership
In a limited partnership, at least one partner has unlimited liability and at least one partner
has limited liability. Partners having unlimited liability are called genera/ partners while partners
having limited liability are called limited partners. Limited partners are exposed to a lower level
of risk. The maximum loss that a limited partner can shoulder amounts to his or her initial
investment. Creditors cannot go after his or her assets.
To compensate general partners for the higher levels of risk they take, they are the only
ones allowed to participate in the management of the partnership. If a limited partner
participates in the management of the partnership, he or she loses the limited liability protection.
He or she becomes a general partner.
Limited Liability Partnership

The limited liability _partnership is a type of partnership that aims to protect innocent
partners from the malpractice and wrongdoings of other partners. This kind of partnership
possesses multiple insurance claims to protect the partners from such wrongful acts of other
partners. The limited liability partnership is mostly used by individuals forming a partnership for
the practice of a profession (e.g., lawyers, accountants, medical professionals, auditors).
Advantages and Disadvantages of Different Forms of Partnership
Form of Partnership Advantages Disadvantages

General Partnership Simple and inexpensive to create Owners(partners) personally
and operate liable for business debts
Limited Liability  Limited partners have  General
Partnership limited personal liability for partners personally
business debts as long as liable for business debts
they do not participate in  More expensive to
management. create than a regular
 General partners can raise partnership
cash without involving outside  Suitable mainly for
investors in companies that invest
the management of the business. in real estate
Limited Partnership  Mostly of interest to  Unlike a limited liability
partners in an old-line company, owners
profession such as law, (partners) remain
medicine, and personally liable for
accounting many types of
 Owners (partners) are not obligations owed to
personally liable for the business creditors,
malpractice of other lenders, and
partners. landlords.
Limited Liability Company Owners have limited personal More expensive to create
liability for business debts even if than a regular partnership
they participate in
management
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Limited Liability Company
The limited liability company is another form of an organization having partnership
characteristics. Limited liability companies have features of both a corporation and a
partnership. The owners are called members and they enjoy limited liability. Unlike the limited
partners in a limited partnership, members of a limited liability company can participate in
management without losing the limited liability protection. (Weygandt et al. 2012)
Corporation
Our law defines a corporation as "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."
This definition emphasizes four things about a corporation.
1. A corporation is an artificial being. It means that it is an entity separate and distinct

from its owners.
2. A corporation is created by the operation of law. Individuals cannot form a corporation
by themselves. The law must play a role in the formation of a corporation.
3. A corporation has the right of succession. Ownership rights can be passed to other
persons through sale, donation, or any other mode of transfer.
4. The law is the source of the powers and attributes of a corporation. Being the source,
the law can likewise restrict the authority of corporations in performing acts.
Unlike in the definition of a partnership, the law did not mention the purpose of a
corporation. Corporations can be organized to generate profit or they may be not-for-profit This
is one classification of corporations. Corporations can also be classified as being publicly held
or privately held. A publicly held corporation has thousands of stockholders (owners) while a
privately held corporation has only a few.
General Features of a Corporation
1. Separate legal existence

Just like a partnership, a corporation is treated by law as an artificial being separate and
distinct from its owners. A corporation can enter into •contracts and transactions under its
name. It can also perform acts that can be done by natural persons except those that are
purely personal such as voting and holding positions in public office.
In a partnership, the acts of the partners bind the partnership even if the partner does not
have the authority to perform such acts as long as the acts are related to the normal business
operations of the partnership. In a corporation, the acts of the owners or stockholders generally
do not bind the corporation. Owners or stockholders are often involved in decision-making
through voting but this does not give them the right to perform acts for the corporation. A
corporation has a management structure that is composed of individuals with specific
authorities.
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2. Limited liability
The limited liability characteristic is an advantage a corporation has over a partnership.
The personal assets of the stockholders of a corporation are protected from the claims of
creditors and other outside parties. Thus, the maximum loss that a stockholder can bear equals
his or her investment. This characteristic is a major consideration of aspiring businessmen who do
not want to be exposed to too much risk. Even if the corporation is bankrupt or has unpaid
claims due to accidents and lawsuits, the stockholders cannot be obligated to pay any
deficiency.
3. Transferable ownership rights

Ownership rights in a corporation are represented by stocks. A stock is an intangible (i.e.,
no physical form) asset evidencing a proportionate share in the properties of a corporation. A
stock is represented by a stock certificate. If an individual has stocks of a corporation, he or she
is an owner of the company. Stocks can be transferred to other persons through sale, donation,
or other modes of transfer. This is not the case in
A partnership. In a partnership, an individual cannot be admitted as a partner without

the consent of all existing partners. Stocks of a corporation can be transferred even without the
consent of other stockholders unless the corporation is privately held.
Transfers of stocks do not result in the dissolution or liquidation of a corporation. Stock

transfers are normal for corporations especially for those that are publicly held. This does not, in
any way, affect the operations of the corporations.
Moreover, a corporation may sell additional stocks to existing stockholders or other

persons outside the company. This enables a corporation to acquire additional capital with
relative ease.
4. Virtually unlimited life

A corporation shall exist for a period not existing 50 years from the date of its formation.
The term of a corporation may, however, be extended for periods not existing 50 years. This gives
corporations virtually unlimited life. As long as the stockholders want to continue business
operations, they are allowed to extend the life of the corporation. There is no limit to the number
of extensions a corporation can avail of.
A corporation is also not affected by the withdrawal, death, and admission of

stockholders. The withdrawal, death, and admission of stockholders only change the
composition of the owners of a corporation, but these events do not require the stockholders to
formulate a new agreement. A corporation does not need to deal with legal formalities
associated with these events, unlike a partnership.
5. Corporation management
The management structure of a corporation is more complex than that of the other forms
of business organizations. Stockholders are the owners of a corporation. However, unlike in sole
proprietorships and partnerships where the owners or partners manage the business,
stockholders may elect a board of directors to manage the corporation. The board of directors
33
represents the interest of the stockholders and they are responsible for creating operating
policies for the company. Stockholders can also be a member of the board of directors.
The board delegates individuals to certain positions. The board selects the president or
chief executive officer and the other vice-presidents. The following exhibit shows the
management structure of a corporation.
6. Government Regulations
Corporations are subject to stricter government regulation than sole proprietorships and
partnerships. Being major contributors to the income of the whole economy, the operations of
corporations are closely monitored by the government. Large corporations provide
employment opportunities to the public and stimulate the growth of the company. The
bankruptcy of a large corporation can cause the whole economy to spiral downwards.
Government regulations are designed not only for the protection of public interest but also for
the stockholders' as well.
7. Double Taxation
The income of a corporation is taxed on the corporate level and the individual level. The
income of a sole proprietorship or a partnership is part of the individual income of the owners. It
is taxed once the owners file their respective tax returns. In a corporation, the income is already
taxed before being distributed to the stockholders. Once a stockholder receives his or her share
of the income, it is included in his or her tax return and will be taxed for the second time.
8. Dividends
When a sole proprietorship or a partnership generates income, it is immediately
distributed to the owners or partners. This is not the case for a corporation. The corporation is not
34
required to distribute to stockholders the income it generated from operations. The stockholders
of a Corporation will only be entitled to receive a share of the income Once the board of
directors approves the distribution. The income distributed to stockholders is called dividends.
Dividends may be in the form of cash, stock, or property. Cash dividends are the
distribution of income in the form of cash. It is normally stated as a nominal amount per share of
stock. For example, if the board of directors declared cash dividends of P2 per share of stock,
an individual holding 1 000 shares of stock will receive P2 000. Stock dividends are the distribution
of income in the form of additional stocks. It is normally stated in percentage terms. For example,
if the board of directors declared a 10% stock dividend, an individual holding 1 000 shares of
stock will receive an additional 100 stocks free of charge. Property dividends enable the
stockholders to receive a certain value of the property of the company for every share of stock
held. For example, if the board of directors declared a property dividend of one unit of inventory
for every share of stock, an individual holding 1 000 shares of stock will receive 1 000 units of
inventory.
Even though the approval of the board of directors is necessary before income can be
distributed, dividends are given to the stockholders regularly to keep them happy. If
stockholders do not regularly receive dividends, they tend to become dissatisfied and sell their
stocks.
Advantages and Disadvantages of a Corporation
Advantages Disadvantages
 Ability to acquire additional  Heavily regulated by the

capital government
 Transferable ownership rights  Double taxation
 Limited liability of stockholders  Not easy to form
 Virtually unlimited life  More expensive to form than
 A large pool of human capital sole proprietorships and
partnerships
Cooperatives
According to the Cooperative Code of the Philippines, “a cooperative is a duly
registered association of persons, with a common bond of interest, who have voluntarily joined
together to achieve a lawful common social or economic end, making equitable contributions
to the capital required and accepting a fair share of the risks and benefits of the undertaking
following universally accepted cooperative principles.
We can see that a cooperative is an association of individuals who share a common

goal. Membership in a cooperative shall be voluntary and available to all individuals regardless
of their social, political, racial, or religious backgrounds and beliefs.
35
According to the same Code, the primary objective of a cooperative is to provide goods
and services to its members and enable them to attain increased income and savings. A
cooperative may be formed by at least 15 persons for any of the following purposes:
1. To encourage thrift and savings mobilization among the members

2. To generate funds and extend credit to the members for productive and provident purposes
3. To encourage among members’ systematic production and marketing
4. To provide goods and services and other requirements to the members
5. To develop expertise and skills among its members
6. To acquire lands and provide housing benefits for the members
7. To insure against losses of the members
8. To promote and advance the economic, social, and educational status of the members
Other characteristics of a cooperative include the following:
1. It can sue and be sued under its name.

2. It has the right to succession.
3. Members of a cooperative are subject to limited liability.
4. It shall exist for a period not exceeding 50 years from the date of formation. The cooperative
term may be extended for periods not exceeding 50 years.
5. A cooperative has its set of board of directors.
6. Income of a cooperative (called net surplus) belongs to its members.
ACTIVITY 1.4
1. What is meant by the term “unlimited liability”?

2. What is the difference between a corporation and a cooperative?
3. Identify the advantages and disadvantages of each form
4. Cite specific problems faced by a partnership but not by a corporation.
References

36
CHAPTER 5 TYPES OF BUSINESS ACCORDING TO ACTIVITIES
LESSON 5
A FOR APPLE
Through its consistently high-quality and innovative products, Apple Inc. has been one
of the leading manufacturing companies in the consumer electronics industry. Currently, it is
one of the largest companies worldwide with a market capitalization of approximately $732
billion. Its best-known products are the Mac computers, iPhones, and iPads.
Apple Inc. designs manufacture and sells its products. Apple products are
manufactured all over the world. With around 200 suppliers, ten thousand employees, and
several production facilities, Apple guarantees that its products are of high quality and value to
its consumers. Its success is attributed to a strong supply chain, empowered employees, and
excellent customer service. Today, Apple continues to develop out-of-the-box products that
leave an impact on its customers' lives.
Source: h ttps://www.app/e.com/supp/ier-responsibi/ity/
A business is an organization that converts inputs or resources such as material, labor, and
overhead into outputs which are usually either goods or services. In this chapter, we will discuss
the different types of business according to activities, their business requirements, and their
advantages and disadvantages. There are three major types of business as follows:
1. Service companies
2. Merchandising companies
3. Manufacturing companies
SERVICE COMPANY
Service companies are firms that generally use their employees to provide intangible
products or services to customers. These services include professional skills, advice, expertise,
and other related products. The primary source of revenues of service companies in the
performance of services is often referred to as service revenues. A law firm is an example of a
service company as it provides legal advice to its clients. A school is also considered a service
company as it relies heavily on its employees (i.e., teachers) to educate its students. A bus
company is a service company though it invests heavily in equipment that is used to perform
transportation services. Other examples of service companies are banks, accounting firms, and
hospitals.
One concept in business is the operating cycle. The operating cycle is the time it takes
for a company to create Products, sell these products, and collect cash payments from
customers. for service companies, the major phases of their operating cycle include paying out
money for employees and Other operating expenses, performing the services, and collecting
cash payments from customers.
To illustrate, consider FDG & Co. which is an accounting firm. To conduct its business, it
hires its employees who are highly skilled accountants and who will carry out engagements with
the firm's clients. FDG & Co. makes sure that its employees are compensated properly and are
37
given adequate training. These employees perform audit, consulting, and tax services for the
clients. Consequently, the clients pay for the services rendered. The operating cycle ends when
FDG & Co. receives the payment in the form of cash.
One of the advantages of a service

company over the other types of business is
the absence of inventory or tangible goods
held by the company. Holding inventory
entails Proper management and control
measures which make it costly. Moreover,
because service companies produce
intangible products, they do not require
production facilities and that frees up cash
for other important business matters.
Considering that these companies

rely on human capital, one drawback to
service companies in the inability to
standardize services as services performed
vary from one client to another. Likewise, to ensure that the services given to customers are of
high quality, constant evaluation and training are administered. With human capital being
limited, training and employee benefits are also vital to attract, retain, and motivate highly
skilled employees.
MERCHANDISING COMPANY
Unlike service companies, merchandising companies sell tangible products. This type of
business buys finished or almost finished goods from their suppliers and resells the same to
customers. Merchandising companies primarily earn revenues from the sale of goods or
merchandise, also known as sales revenue or sales. There are two types of merchandising
companies—retailers and wholesalers. A merchandising company that sells goods directly to
customers is called a retailer. A wholesaler is a merchandising company that sells goods to
retailers. For instance, the retailer National Book Store buys school supplies from the wholesaler
Pilot.
The operating cycle of a merchandising company is typically longer than that of a
service company. It starts with the purchase of goods to be held for resale, also known as
inventory. The company eventually sells the inventory to customers. The cycle ends with the
receipt of cash payments. As you can see, the purchase of inventory and its subsequent sale
lengthen the cycle.
As an example, National Book Store buys school supplies from various suppliers such as
Pilot, Cattleya, Crayola, and 3M. These school supplies which are inventory of the company are
put on the store racks and are sold to customers afterward. The cycle ends when the cash
payments are received by the company.
38
The existence of a tangible product
provides leeway to merchandising companies
to make customers notice their products,
thereby promoting sales. Relative to service
and manufacturing companies, these
companies generally consume less
conversion time, effort, and cost.
As stated holding inventory involves

cost and this becomes a disadvantage to
merchandising companies. For instance,
Daniel, who owns a 24-hour convenience
store, has to ensure that there is a supply of goods enough to meet customer demand. He orders
from suppliers based on the expected sales and pays for the goods and the cost of delivery.
Once goods are received, they are put in the proper storage room or equipment to preserve
product quality. Security measures which include the installation of CCTVs and detectors are
being implemented to safeguard the goods. All these activities for managing inventory require
cost which involves regular monitoring.
MANUFACTURING COMPANY
Manufacturing companies, or simply manufacturers, are relatively complicated

organizations than service and merchandising companies. As the name suggests,
manufacturers create their products. They use raw materials, components, or parts that are
processed using machines, computers, and Labor to produce finished goods. Manufacturers
typically employ large-scale production which is done in manufacturing plants. Similar to
merchandising companies, they earn revenues primarily from the sale of manufactured
products. The products of manufacturing companies can be sold directly to consumers,
retailers, and other manufacturers. For example, Toyota builds cars and sells them to customers
through their dealers nationwide. Meanwhile, Unilever manufactures its products like Dove and
Cream Silk and sells them to retailers such as SM and other supermarkets. 3M manufactures
adhesives that are bought and used by aircraft manufacturers in creating their products.
Since a manufacturing company produces its products, its operating cycle generally has
the longest period compared to service and merchandising. The cycle has an additional phase
which is the production of goods. These goods are also held as inventory and later sold to their
customers. Likewise, the operating cycle of a manufacturing company ends with the collection
of cash payments.
As an illustration, imagine Nike Inc. which is a leading shoe manufacturer. It owns more
than 600 factories across the globe where Nike shoes are made. It acquires its raw materials
from various suppliers, hires more than a million factory workers, and invests heavily in
technology. Using all these inputs, Nike shoes are manufactured and ensured that they reach
quality standards. After passing the standards, the shoes are shipped to distributors and retailers
who will sell the products to consumers. In early 2015, Nike Inc. has a day operating cycle which
39
is comprised of a 95-day average inventory processing period and a 40-day average
receivable collection period.
One of the advantages of
manufacturing one's product is
quality control wherein
manufacturing companies can
ensure that their products meet the
standards set. Multiple quality
inspections are carried out to detect
spoilage and prevent low-quality
goods from falling into the hands of
the customers. Just like
merchandising companies,
manufacturers benefit from having
products that are easily noticed by
customers, thus promoting sales.
Manufacturers generally need

initial capital outlay to run production facilities and that requires a large sum of money. In
converting the inputs to finished goods, overhead costs such as utilities and rent expenses are
incurred. These costs require frequent monitoring to make sure that the companies are not
overspending or wasting resources. Also, manufacturers need to finance their quality control
procedures to avoid product failure costs. Moreover, the existence of inventory implies further
costs of managing, handling, and storing manufactured goods.
ACTIVITY 1.5
1. Research different businesses in your community and identify their business type. Choose at
least one company from each business type and describe its different activities. Present your
research in the form of charts or graphs that will present your research data more organized.
References

40
CHAPTER 6 ACCOUNTING CONCEPTS AND PRINCIPLES
LESSON 6 THE RULES OF LIFE
Not a single person in the world lived without following some rules. We have been
subjected to rules all our lives. When you were young, your parents probably told you not to
sleep late at night, not to play too many video games, or not to go outside when it is already
dark. At school, you were introduced to the new set of rules. No sleeping during class time, no
loitering around, doing all your homework, and coming to school on time are just some of these
rules. After you have finished school, the workplace will once again impose another set of rules.
Rules impede our freedom, but it is for the common good. Can you imagine our society without
a law that governs us? Somebody could steal your phone or hurt you physically, and it is
perfectly legal. Without rules, we would live in chaos.
Rules are not only applicable to our day-to-day lives. In the course of our study, we have
encountered rules, concepts, principles, and assumptions that help us in understanding the
concepts being taught. In economics, we have the ceteris paribus (i.e., all else equal)
assumption whenever we study the effect of a specific factor in the demand and supply. In
mathematics, there are multiple theorems and postulates to guide us in problem-solving. These
rules, concepts, principles, and assumptions are not created just to make students' lives harder.
They are put in place for students to better understand the concept as well as its limitations.
Just like all other fields of study, accounting also has concepts, principles, and
assumptions. Collectively, these concepts, principles, and assumptions serve as a guide, and
simply, the study of accounting. In this chapter, we will tackle all the general accounting
concepts and principles.
Accounting concepts, principles, and assumptions are essential in the practice of

accountancy. Financial statements become more comparable and more useful to users if these
concepts, principles, and assumptions are followed by businesses. We can look at these as a set
of rules that govern the accounting process.
Accounting concepts, principles, and assumptions serve as the foundation of

accounting to avoid misunderstanding and enhance the understanding and usefulness of
financial statements. (Valix et al. 2013)
In this chapter, various accounting concepts, principles, and assumptions will be

explained. Accounting standards that are mentioned in earlier chapters will also be discussed
in greater detail. The topics to be discussed in this chapter are as follows:
1. Accrual accounting
2. Matching principle
3. Use of judgment and estimates
4. Prudence
5. Substance over form
6. Going concern assumption
41
7. Accounting entity assumption
8. Period assumption
9. Generally Accepted Accounting Principles (GAAP)
10. International Financial Reporting Standards (IFRS) and Philippine Financial Reporting
Standards (PFRS)
ACCRUAL ACCOUNTING
The fundamental idea of accrual accounting can be stated as follows:
"The effects of business transactions should be recognized in the period in which they
occurred. Income should be recognized in the period when it is earned regardless of when the
payment is received. Expenses should be recognized in the period when it is incurred regardless
of when the expenses are paid."
Suppose Andrew, a budding entrepreneur, established a merchandising business that

sells ready-to-wear clothes to different ukay-ukay stores in the country. The income from
Andrew's business primarily comes from selling goods to customers. Sales to customers can be
for cash or on credit. If the business was able to sell goods for cash, this will be recorded in the
accounting records of the company. On the other hand, if the goods were sold on credit, the
transaction should still be recorded in the accounting records as accounts receivable.
This is the essence of accrual accounting. An accountant does not have to wait for the
cash to be received or for cash to be paid before he or she records a business transaction.
Because of accrual accounting, the use of accounts such as accounts receivable, accounts
payable, prepaid expenses, accrued expenses, deferred income, and accrued income are
possible. You will encounter these accounts in the later chapters.
Accrual accounting also results in financial statements that are more accurate and more
reliable in terms of assessing the past performance of the company. Since income is recognized
when earned and expenses are recognized when incurred, financial statements for a particular
period properly reflect the financial transactions about that period.
The opposite of accrual accounting is the cash basis of accounting. Under the cash basis
of accounting, income is recognized when cash is received and expenses are recognized when
cash is paid. As its name implies, under the cash basis of accounting, the receipt and/ or
Payment of cash is a requisite before transactions are recorded in the accounting records of a
company.
Matching Principle
The matching principle is closely related to accrual accounting. Under the matching
principle, expenses are recognized in the same period as the related revenue. Revenues of a
business always come with expenses. No business can generate revenues without incurring
expenses. The matching principle states that related revenues and expenses should always go
42
together. In other words, if the revenues are recorded in period 1, the related expenses should
also be recorded in period 1.
For example, Rudy, a car salesman who works for Honda, has a monthly salary of ₱30
000. Aside from that;, he receives a commission of 5% for all the sales he made for the month.
During December, he was able to sell 10 cars for a total amount of ₱I 2M. The ₱I 2M is recorded
as sales of the company. By selling 10 cars for the month, Rudy is entitled to receive ₱630 000
(i.e., P30 000 monthly salary plus ₱600 000 commission). The monthly salary of Rudy plus his
commissions are expenses of the company. By the end of the month, the salary Rudy and his
commissions are still not yet paid. Under the matching principle, the ₱630 000 will be recorded
as an expense in December even though it is not yet paid since it is related to the ₱I2M in
revenues. Without the matching principle, the ₱630 000 may be recorded as an expense in
January when the payment to Rudy is made.
Remember that under the matching principle, expenses follow the related revenues. Like
accrual accounting, the matching principle also provides more accurate and more reliable
information in the financial statements. It prevents understatement of expenses in one period
while overstating expenses in the next period.
Moreover, under the matching principle, there is a cause-and-effect relationship

between revenues and expenses. If this relationship does not exist between revenues and
expenses, the expenses should be recognized immediately in the accounting records of the
company. Advertising and marketing expenses are the most common examples of this kind of
expense. Since the related benefit that is expected to be derived from advertising and
marketing cannot be measured reliably, these expenses are recognized immediately.
USE OF JUDGMENT AND ESTIMATES
Accounting estimates are approximations made by accountants or the management in

the preparation of financial statements. The use of reasonable estimates is an essential part of
the preparation of financial statements and does not undermine their reliability. (International
Accounting Standards 8) Some items in a company's accounting records such as cash;
property, plant, and equipment (PPE); and accounts payable can be measured precisely. For
these items that can be measured with precision, the use of estimates is not required. As you
study higher levels of accounting, you will encounter items in a company's accounting records
that cannot be exactly measured. Thus, these items require the use of accounting estimates.
Warranty expense is an item in the accounting records that requires the use of estimates.
A warranty is a guarantee made by the seller to the buyer promising to repair or replace the
thing sold if necessary within a specified period. When a seller sells goods, there are revenues
generated that are recorded in the company's accounting records. According to the matching
principle, all related expenses should also be recorded in the same period the revenues are
recognized. Warranty expense is related to the revenues generated from the sale of goods. The
problem is what amount of warranty the company should recognize in the accounting records.
43
A company is not entirely sure when warranties will be performed by the company. It can
be in the same period as the related revenues, one year after the date of sale, or even further
into the future. Because of this, the warranty expense in a company's accounting records is
usually estimated based on historical data.
However, the use of accounting estimates cannot be abused by an entity by purposely

overestimating expenses. Some companies overestimate expenses to decrease net income
and decrease the taxes payable. Judgment used in making accounting estimates should be
backed up on a reasonable basis. It is more desirable to use less judgment in the accounting
process because the use of judgment leads to more subjective financial statements.
PRUDENCE
Prudence in the accounting sense is also called conservatism. Some financial
transactions are sometimes uncertain (like the warranty expense in the previous example) when
they will occur. Nevertheless, we still need to report these transactions if they pertain to a specific
period. In reporting these transactions, an accountant needs to apply the concept of
prudence. When applying the concept of prudence, an accountant makes sure that income
and assets are not overstated and liabilities and expenses are not overstated.
According to Valix et al. (2013), "In the simplest words, conservatism means in case of
doubt, record any loss and do not record any gain." For example, when an accountant is unsure
whether or not to recognize an expense, the concept of prudence states that he or she should
recognize it in the accounting records. On the other hand, if an accountant is unsure whether
or not to recognize income, prudence states that he or she should not recognize it.
Albeit prudence is the preferred course of action when making judgments; deliberately
being too conservative is not an allowed practice. Like what is stated in the foregoing,
companies might claim that they are just exercising prudence when recognizing expenses even
though the main purpose is to bloat expenses for lower tax payments.
SUBSTANCE OVER FORM
Information presented in the financial statements of a company should truthfully and

faithfully represent the financial condition and financial performance of the company. For this
to be possible, an accountant should look at the substance of every financial transaction rather
than its legal form.
Most of the time, the substance of a transaction does not differ from its legal form. An
example is the sale of goods. In this transaction, there can be no doubt that the substance and
legal form of the transaction is a sale.
A transaction where the substance differs from the legal form is a lease. In a lease, the
lessor allows the lessee to use the former's property in exchange for a periodic fee. However,
when ownership of the property transfers to the lessee at the end of the lease, the substance
differs from the legal form. In this case, the transaction is a sale of property with installment
44
payments instead of a lease. The lessee will record an asset and a liability in his or her accounting
records instead of recognizing an expense.
When the substance differs from the legal form, follow the substance of the transaction.
In the example given, the substance is a sale of property in installment payments while the legal
form is a lease. This transaction should be treated as a sale of property in installments since
substance prevails over legal form.
GOING CONCERNS ASSUMPTION
The going concern assumption states that the operations of a business will continue
indefinitely into the future. This means that the operations of a business will not stop short and it
will not be forced to liquidate its assets to pay off its liabilities. The going concern assumption
allows accountants to defer recognition of expenses in the future.
For example, Company A rents a building for ₱I00 000 per month. On January 1, 2016,
the company paid the rent for two years in the amount of ₱2 400 000. Under the going concern
assumption, the company can recognize the part of the ₱2 400 000 that is not yet incurred. On
January 1, 2016, the company has not yet used the building but already paid the rent. In this
case, the accountant can record an asset (i.e., prepaid expense) instead of recognizing an
expense immediately. If the entity is not a going concern, there is no point in recognizing the
payment as an asset since the company will not derive all benefits from it. A company that is
not a going concern will halt operations shortly, so the payment of ₱2 400 000 will be recognized
wholly as an expense instead of recording an asset.
However, if there is substantial doubt about the ability of a company to continue as a

going concern, the company can abandon this assumption. The following items are evidence
that a company is not a going concern:
1. The results of operations consistently show losses.

2. Inability to pay the obligations of the company in time
3. Loan defaults
4. Suppliers do not sell on credit to the company.
5. Legal proceedings against the company
ACCOUNTING ENTITY ASSUMPTION
According to the accounting entity assumption, the business (which can be a sole
proprietorship, partnership, or corporation) is separate from the owners, managers, and
employees operating the business. Likewise, if a person owns multiple businesses, each business
is distinct from all the others. This means that if a person has three businesses, then each business
will keep its accounting records. The assets and liabilities of the three businesses should not be
mixed.
45
Personal transactions of an owner should also not affect the financial statements of his or
her businesses. If an owner incurs expenses for the repair of his or her vehicle, this should not be
reflected in the financial statements of any of his or her businesses. Similarly, if an owner acquires
assets for his or her use, this transaction should also not be recognized in the accounting records
of the entity. Whether the effect is beneficial or detrimental to the company, an accountant
should not record any personal transaction of the owners, managers, or employees.
The main purpose of the accounting entity assumption is for the fair presentation of the
financial statements of the company. If the personal transactions of owners, managers, and
employees are recognized in the accounting records of the business, the financial statements
will not accurately represent the results of operations of the business.
TIME PERIOD ASSUMPTION
The purpose of financial statements is to show the overall results of the operations of a
company. However, the final and comprehensive report of the results of company operations
cannot be produced until the company is at the end of its life (i.e., after liquidation).
Users of the accounting information of a company need periodic reports to enable them
to make economic decisions. An owner or stockholder needs reports consistently to decide if
he or she will still keep his or her ownership interest in the company. A supplier needs reports
consistently to decide if it is still beneficial to transact with the company. This is where the period
assumption comes into play.
The period assumption states that the indefinite life of a company can be divided into
periods of equal length for the preparation of financial reports. Normally, the periods span for
one year. Every year, most businesses produce financial reports for the benefit of the users of
accounting information. Still, some businesses produce financial reports on periods less than or
above one year. The frequency of financial reporting also depends on the normal operating
cycle of a business.
The accounting period of a business may be a calendar year or a fiscal year. A calendar
year is a 12-month period that ends on December 31. A fiscal year is a 12-month period that
ends on any month of the year. Some companies use the fiscal year since the peak of their
operations does not occur in December. Companies usually want to present good results for
the fourth quarter of their operations that is why some companies prefer to use the fiscal year.
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)
The Generally Accepted Accounting Principles (GAAP) consist of accounting principles,

standards, rules, and guidelines that companies follow to achieve consistency and
comparability in their financial statements. Companies that apply the GAAP help not only
external users of accounting information but also the management as well. Since the GAAP
46
enhances the consistency and comparability of a company's financial -statements, it will be
easier for external users to examine if the company is doing well currently or about its past
performance. Simultaneously, GAAP also helps the management in understanding trends
persistent in the company. Management can also compare past and current performance to
check the strong and weak points of company operations.
The accountancy profession is continuously evolving. Due to the rapid advancement of

technology, there are new kinds of transactions encountered today that were not present in
the past. The standards followed by accountants in the practice of their profession should also
adapt to these changes. Thus, the GAAP is also being developed and improved continuously.
Another feature of the GAAP is that it is agreed upon by practitioners. Individuals in the
accountancy profession are the ones who create accounting standards such as the GAAP. The
formulation, development, and modification of the GAAP go through a rigorous process
involving professional judgment and research.
INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)
The International Financial Reporting Standards (IFRS) are pronouncements issued by the
International Accounting Standards Board (IASB) that intend to enhance globalization, the IFRS
will provide a way for users of accounting information to easily understand the results of
operation all around the globe.
In the past, the function of the IASB is performed by the International Accounting
Standards Committee (IASC). The pronouncements of the IASC are called International
Accounting Standards (IAS). Up to this day, the IASB still adheres to the SIAS in addition to their
pronouncements of the IFRS.
In the Philippines, the developments of accounting standards that will be used in the
country consider the pronouncements issued by the USA Financial Accounting Standards Board
(FASB) and the IASB (Valix et al.2013). The Philippines follows the Standards of both the IAS and
the IFRS. In contrast, the USA follows guidelines provided by the GAAP. The Philippines is fully
compliant with the IFRS effective January 2005.
The following factors are considered in the decision to adopt the IFRS (Valix et al. 2013):
1. Philippine organizations’ support of international accounting standards.

2. Increasing internalization of businesses which greatly calls for a common language for
financial reporting.
3. Improvement of international accounting standards or removal of free choices of
accounting treatments.
4. International accounting standards are being recognized by the World Bank, Asian
Development Bank, and World Trade Organization.
47
PHILIPPINE FINANCIAL REPORTING STANDARDS COUNCIL (FRSC)
The Philippine Financial Reporting Standards Council (FRSC) issues standards to be used
in the Philippines in the form of Philippine Financial Reporting Standards (PFRS).
The PFRS include all of the following:
1. Philippine Financial Reporting Standards (PFRS) which corresponds to International

Financial Reporting Standards (IFRS)
2. Philippine Accounting Standards (PAS) which corresponds to International Accounting
Standards (IAS)
3. Interpretations of accounting standards issued by the Philippine Interpretations
Committee in accordance with interpretations of the International Financial Reporting
Interpretations Committee (IFRIC) and the Standing Interpretations Committee.
ACTIVITY 1.6
I. Write the correct answer in every item. Below are accounting concepts and
principles. Match each case or transaction and select the correct accounting concept and
principle.
Accrual Accounting Accounting Entity Assumption
Going Concern Assumption Prudence Time Period Assumption
Use of Judgment and Estimates Matching Principle
1. The indefinite life of a company can be divided into periods of equal length for the
preparation of financial reports.
2. Income and assets are not overstated and liabilities and expenses are not overstated.
3. Income should be recognized in the period when it is earned regardless of when the payment
is received.
4. The business is separate from the owners, managers, and employees operating the business.
5. Expenses recognized in the same period as the related revenue.
6. Approximations made by accountants or the management in the preparation of financial
statements.
7. It is assumed that the operations of a business will continue indefinitely into the future.
48
8. Joe, a business owner, incurs expenses for the repair of his house. This expense should not be
reflected in the financial statements of his business. It should be considered as a personal
expense.
9. Joey, a car salesman, rendered service for a car company in December. Joe was able to sell
five cars in December. However, he was paid by the company in January of the next year. Joe's
salary will be recorded as an expense of the car company in December.
10. A company prepares financial reports every year for the benefit of its stockholders.
11. A company records warranty expense even though it is not entirely sure when warranties will
be performed.
12. Credit sales are recorded by a company as revenues even though no cash is received.
References

49
CHAPTER 7 THE ACCOUNTING EQUATION
LESSON 7 THE STATEMENT OF ASSETS, LIABILITIES, AND NET WORTH
We always hear about the Statement of Assets, Liabilities, and Net Worth (SALN) of our
public officials. Almost every year, we always hear how Senator A increased his or her net worth
by a certain amount, or how Senator B becomes the richest senator in the Philippines, while
Senator C is the poorest. Generally, through this public document, we can see and monitor the
changes in the net worth of each of these officials of our country. Understanding a SALN is quite
straightforward as it is just an information sheet enumerating the properties and debts of a public
official. The document can be generally divided into three parts: (1) the official's personal
information, (2) the listing of his or her assets and liabilities, and (3) the official's sworn statement.
(See a sample of SALN).
However, have you ever wondered how the net worth of each official is computed? We
can determine anyone's net worth by just deducting the individual's liabilities (what the
individual owes) to his or her assets (what he or she owns). The result will equate to the net worth
of the individual which, in a sense, measures his or her value in money.
It may be quite a simple process, but it is an effective tool to see if whether or not that
particular official can justify his or her wealth. For example, if you compare the SALN of Senator
A from 2009 to 2010, the increase in the net worth of this senator should have been evidenced
by his or her earnings. But when the increase is substantially greater than his or her compensation
as a senator, there might be something suspicious going on.
This computation of the net worth of an individual is derived from one of the most
fundamental concepts in the study of accounting—the accounting equation. This equation
applies to all business organizations regardless of their size and form.
BASIC ACCOUNTING EQUATION
Let us continue our study through the introduction of the fundamental concept of the
accounting equation. The equation has two elements that equally divide the entity into two
parts. The left side of the equation represents what the entity owns. On the other hand, the right
side represents those that the company owes.
Assets = Liabilities + Equity
The left side of the equation represents what the company owns. These are resources
that the entity controls to attain future benefits. On the other hand, the right side represents the
claims of the different parties to the company's assets. Liabilities represent the claims of the
entity's creditors while equity represents the residual interest of the owners of the entity.
50
Also, remember that just like in any equation, the two sides of the equation should always
be balanced. Hence, what the company owns should always equal what it owes to its owners.
ELEMENTS OF ACCOUNTING EQUATION
ASSETS
As we have learned earlier; assets are resources that an entity owns to derive some future
benefits. These assets are used by the company in its normal operations such as the
manufacture of goods or delivery of services. The main feature of these assets is their capability
to give benefits to the entity. These benefits are usually in the form of their ability to directly or
indirectly increase the inflow of cash to the entity or a reduction of its outflows.
Some examples of these assets are the following:
1. Cash
Generally, it is the money that we use comprising of the bills and coins we use in our
everyday lives to buy the goods that we want and also avail the services that we need.
However, when accounting for cash, we also consider cash as the money that is deposited in
the banks and even undeposited checks from customers.
2. Accounts Receivable
This represents amounts that are collectible from customers. They arise when a business
sells its goods or services on account or credit.
3. Inventories
When going to a sari-sari store, you would notice piles of assorted products being offered
to be sold. One can easily find various items such as food and household items to satisfy
whatever he or she needs. Such products are normally owned by the sari-sari store. These
products are inventory which is normally held for sale by the store in its normal operations.
4. Equipment
Pandesal shops would need ovens and furnaces to properly and create their goods. The
product of these ovens is the pandesals which would be sold later on and eventually increase
the cash of the shop.
5. Land and Building

In most businesses, a physical store is necessary for them to operate. For example, how
can a local carenderia function without an actual store? Where will a barbershop operate
without its building? Such buildings are also assets of the businesses.
These buildings are owned by the company so that they can use them for their business
to operate normally.
51
6. Intangible Assets
When we think of the things we can own, we normally think of tangible things or those
that can be seen and touched. However, assets also encompass intangible things that can
neither be seen nor touched.
For example, the software used by computer shops is assets that they own. Even though
one cannot touch the software, it is still an asset of the computer shop that will earn the shop
future benefits.
LIABILITIES
Liabilities are one of the claims of external parties from the entity. They are the debts of
the entity to external creditors. These debts do not always have to be paid in money. Some of
these liabilities are in the form of obligations to do some service or even give something. These
liabilities can take form in the following:
1. Accounts Payable
When a local supermarket or convenience store like 7-Eleven buys its goods, it is unusual
for it to immediately pay cash for such goods. Normally, it would only incur an obligation to pay
its supplier after a certain number of days.
For example, when it gets a delivery of, milk, it might have an agreement to pay its
supplier only after 30 days. Thus, in the meantime that the product has not been paid yet, it
would only carry a "payable" in its books.
2. Unearned Revenue
Telecommunication companies such as Globe and Smart normally offer prepaid loads
to customers. These load credits Can be later on used by customers for text messages or to call
other people. On the other hand, when Globe or Smart receives payments from customers, it
creates an obligation for them to deliver their services. Such obligations to give their service are
recorded as liabilities.
EQUITY
The equity reflects the residual claims or net assets of the owners of an entity. This is similar
to the net worth part of the SALN of our public servants. Take note that these are only residual
claims of the owners since the creditors get their share of the entity first before the owners are
given their share. This is also why the net worth of individuals is computed by subtracting their
liabilities from their assets.
Generally, equity comes from two sources. The first one comes directly from the owners
in the form of investments of capital. The other comes from the income of the business from its
normal operations. The net income or net loss of the business from its operations can be
determined by using the following equation:
52
Revenues - Expenses = Net Income / (Net loss)
A business will have net income if its revenues exceed expenses and will have a net loss
if its revenues are less than its expenses.
1. Revenues
A business earns revenue when it sells its products or its services. When you go to a store
and buy a phone, the store earns revenue. When you get a haircut from a barbershop, the shop
also earns revenue. Generally, we can say that a business earns revenue when it expects to
earn an economic benefit in the form of an increase in assets such as cash or a decrease in
liabilities. Other terms used for revenue are sales, rent, fees, etc.
2. Expenses
The matching principle states that no revenue can be earned without incurring
corresponding expenditures. As such, when a store sells a phone, aside from getting cash for
the phone, it also incurs costs for the goods it has sold. On the other hand, such is also true when
services are rendered. In the barbershop, when someone gets a haircut, the barbershop incurs
costs in the form of salary for its employees.
3. Capital
The capital account of the equity represents the net investments of the business. This
means that any contribution of the owner which increases the assets of the business or
decreases its liabilities will increase the capital account. For example, when creating a business,
an owner normally contributes a significant amount of cash to kickstart the business. Such
transaction increases the capital account of the business. Note that it does not only have to be
cash to increase the capital account. An owner may even contribute equipment or land to
increase his or her capital.
Moreover, since capital represents the net investments of the investments, withdrawals
by the owner are also taken into consideration. As such, when an owner gets cash from the
business to use for personal use, its capital accounts are deducted.
Lastly, at the end of each accounting period, the net profit or net loss of a business is also
"closed" to this account. Closing entries will be discussed in the next chapters.
Moreover, the equity portion of the accounting equation is where the revenues and
losses incurred by the company are taken into consideration. Thus, when a company sells its
products, the company earns revenues and therefore increases its equity as well. On the other
hand, when it pays its bills or even just loses some assets, the entity incurs expenses and losses,
thereby decreasing its total equity.
USING THE ACCOUNTING EQUATION

When using the accounting equation, one must remember the accounting identity
which means that equality must be maintained throughout all transactions. The reason for this is
that the assets of the entity will always be claimed by another party.
53
Also, another way to explain this is because of the identity property in mathematics which
states that both sides of an equation should be equal to each other at all times.
As such, to maintain this identity, transactions always have a dual effect on the
accounting equation. Otherwise stated, each transaction of the entity would have to affect at
least two accounts for the equation to remain in balance. Such accounts may be on the same
side, that is, (+ Asset & - Asset) or on both sides of the equation, that is, (+Asset & +Equity) or
(+Asset & +Liability).
Recall that the accounting equation is as follows:

Let us also note that each element of the equation has different elements involved. For
example, assets include cash, accounts receivable, inventories, equipment, etc. Thus, we can
now expand the equation by a basic breakdown of its components:
ASSETS = Liabilities + Equity
Cash Account Equipme Accou Unearned Owner Revenue Expenses

Receivable nt Land nts Revenue ’s
and Payab Capit
Inventories Building le al
Intangibl
e
Assets
Given these definitions, let us have some examples to visualize its proper use. Let us look
into the familiar restaurant business and check how each recorded economic event affects the
accounting equation of the business.
Manang Rosie's Famous Barbecues

1. Initial Investment. Manang Rosie has been well known for her delicious variety of
barbecues. As such, she decided to open up a barbecue store in her neighborhood The store
would be a sole proprietorship business. To do so, she invested P25 000 as initial capital.

Cash (1)+₱25 000 Owner’s Capital
(1)+25000
Take note of the dual effect of the transaction. Notice that the transaction affected at
least two accounts. In this case, the transaction affected the asset and equity accounts.
The invested cash is recorded in a separate account on the assets side while the
corresponding increase in the ownership stake of Manang Rosie is denoted by the increase in
the Capital account.
2. Purchase of equipment. To create her famous barbecue, she would need the proper
equipment to cook it. Thus, she went to the local hardware store and bought the necessary
equipment such as grills and utensils for ₱20 000.
54
Cash Owner’s Capital
₱25 000 ₱ 25 000
(2)-₱20 000 (2)+₱20 000

₱ 5 000 ₱ 20 000 ₱ 25
000
₱ 25 000 ₱ 25 000
In this transaction, the total amounts of assets did not change at all. Comparing it to the
transaction (1) wherein both sides of the equation were affected, there was merely a transfer
of accounts from cash to equipment. As such, the right side of the equation remains constant
since it was not affected at all by the transaction.
3. Purchase of inventories through credit. Manang Rosie's barbecues require only the
freshest meat which can be bought from Ate Shayne's store in the market. Since they cost ₱I0
000, Manang Rosie does not have enough money to purchase this. Despite that, Manang Rosie
is already a trusted suki of this store. As such, Ate Shayne decided to give the meat to Manang
Rosie on the condition that she will have to pay her in 30 days.

Cash Equipmen Inventories Accounts Payable Owner’s Capital
₱5 000 t (1)+₱10 000 (3)+10 000 ₱25 000
₱20 000
₱5 000 ₱20 000 ₱10 000 ₱10 000 ₱25 000
₱35 000 ₱35 000
In simple terms, purchasing through credit means through a payable or, in Filipino,
“utang”. As such, notice that the transaction increases the liabilities portion of the equation. It
represents a claim of the creditors (Ate Shayne) to Manang Rosie.
Correspondingly, the incurred payable enables Manang Rosie to earn new assets in the
form of meat, the meat will be later on converted and sold to customers but for now, let us
record it as inventory.
4. Payment of expenses. To set up a business, one of her friends told her that she has to
obtain business and other permits from the local government. As such, she paid ₱I 000 to obtain
such permits.
55
Cash Equipment Inventories Accoun Owner Expenses
ts ’s
Payabl Capit
₱5 000 ₱20 000 ₱10 000 e al
₱10 000
₱25 000
(4)-₱1,000 (4)-₱1,000
₱4 000 ₱20 000 ₱10 000 ₱10 000 ₱25 000 -₱1 000
₱34 000 ₱ 34 000

When operating a business, there would be normal incurrence of expenses that is
necessary for the business to fully function. One of these expenses is the business permits. These
permits are licenses given by the government to make sure that only legitimate or safe
businesses operate.
Moreover, other expenses include utility payments such as those for water and electricity.
They also include those paid for the repair and maintenance of the business' equipment.
As you can see here, the transaction affected two parts of the equation: the assets and
the equity portion. In most expenses, cash is used to pay for these activities. Thus, the decrease
in cash also represents a decrease in the assets portion. On the other hand, it also decreases
the equity portion of the equation since it represents an outflow of the residual interest of the
owners.
Later on, in the next chapter, you will learn more about the different accounts that would
increase or decrease the equity account. These include income, expenses, gains, and losses.
5. Sale of barbeques. With everything in place, Manang Rosie can now sell her famous
barbecues. During the first day of her new business venture, she was able to sell 1 000 barbecues
with a selling price of P20 000. Half of which was paid cash. The other half was to be paid in 5
days.
Cash Account Equipm Inventori Account Owner’s Revenue Expense

s ent es s Capital s
Receivabl Payabl
₱4 000 e e ₱25 000
₱ 20 000 ₱10 000 ₱10 000 -₱1 000
(5)+₱10 (5)+₱10 (5)+₱20

000 000 000
₱14 000 ₱10 000 ₱20 ₱10 ₱10 000 ₱25 ₱ 20 -₱1
000 000 000 000 000
₱54 000 ₱54 000
56
In this transaction, more than two accounts have been affected. However, the totals of
both sides remain equal. The accounting equation only requires identity in terms of amounts but
not necessarily in the number of effects on each side.
Thus, as illustrated by this transaction, there can be transactions that affect five asset
accounts but only one liability account.
Correspondingly, the 1 000 barbecues account for half of the total supply of barbecues
of Manang Rosie.
Cash Accoun Equipm Inventori Account Owner’s Revenue Expens
ts ent es s Capital es
Receiva Payabl
ble e ₱25 000
₱14 000 ₱20 000
₱10 000 ₱ 20 000 ₱10 000 ₱10 000 -₱1 000
(5)-₱5 (5)-₱5
000 000
₱14 ₱10 000 ₱20 ₱5 ₱10 000 ₱25 ₱ 20 -₱6

000 000 000 000 000 000
₱49 000 ₱49 000

Note that a single transaction affected multiple accounts in the equation. There is no limit
actually as to how many accounts each economic event affects.
In this case, when one sells goods, aside from earning money and revenue from the
transaction, one would also have to incur expenses. In this case, when Manang Rosie sells
barbecue, naturally, her barbeques should also decrease. It would be unfair to the customers if
they do not receive their barbecues. As such, the transaction also included a decrease in
Manang Rosie's assets (inventory) and a decrease in equity (expense).
SUMMARY OF TRANSACTIONS
On the next page is a summary of all the economic events of Manang Rosie's Famous
Barbecues. Each line item has a reference number that corresponds to the transaction number
of the economic event.
= Liabilities + Equity
Assets
Account Equipm Inventori Account Owner’s Revenue Expense
s ent es s s
Cash Receiva Payabl Capital
ble e
(1) +₱25 +₱25

000 000
57
(2) -₱20 000 +₱20
000
(3) +₱10 +₱10

000 000
(4) -₱1 000 -₱1 000
+₱20
(5) +₱10 +₱10 000 000
000
-₱5 000 -₱5 000

₱14 000 ₱10 000 ₱20 ₱5 ₱10 ₱25 ₱20 -₱6
000 000 000 000 000 000
₱49,000 ₱49,000
ACTIVITY 1.7
1. What is the accounting equation?
2. Differentiate assets, liabilities, and equity. Give three examples of assets and two
examples of liabilities.
3. Define the capital account under equity.
4. What will make it increase in value?
5. How is net income / (net loss) determined?
6. Differentiate revenues from expenses.
References
58

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CHAPTER 1

Accounting involves the processes of identifying, recording, and communicating

THE ACCOUNTING PROCESS

5. Accounting is an information system. Accounting is recognized and characterized as a

The main functions of accounting can be summarized as follows:

Keeping Systematic Record of Business Transactions

Protecting Properties of the Business

Communicating Results to Various Parties in or Connected with the Business

Meeting Legal Requirements

Many consider the dissemination of the double-entry bookkeeping of Luca Pacioli in

The modern profession of the chartered accountant originated in Scotland in the

1. Describe and explain the nature of accounting

2. Explain the functions of accounting in business

http://www.accountingtheory.com/nature-and-scope-of-accounting.html. Retrieved on Dec.

Accounting is a broad field of study. It ranges from the usual recording of

Financial accounting is a branch of accounting primarily handling the recording of

GENERAL PURPOSE FINANCIAL STATEMENT

Management accounting is a branch of accounting that focuses on the preparation of

ROLE OF MANAGEMENT ACCOUNTANTS

According to the Chartered Institute of Management Accountants (CIMA), chartered

 Advise managers about the financial implications of projects

It is emphasized that management accounting is used in deciding how the business

MANAGEMENT ACCOUNTING SKILL SET

In addition to strong accounting fundamentals, management accountants should also

 Communication. Management accountants should be able to identify what information

According to Section 109 of the Presidential Decree government accounting is defined

1. To provide information concerning past operations and present conditions

NEW GOVERNMENT ACCOUNTING SYSTEM (NGAS)

GOVERNMENT ACCOUNTING PROCESS

Cost accounting is a branch of accounting that provides information for management

TERMS USED IN COST ACCOUNTING

The Bachelor of Science in Accountancy (BSA) in the Philippines is normally a 5-year

ADMISSION REQUIREMENT FOR BSA

According to the Commission on Higher Education (CHED), the standards of admission

 Deciding and implementing new accounting and auditing standards

1. What are the similarities and differences of financial accounting

2. Differentiate general-purpose financial statements from special-purpose financial

4. How does management accounting provide value to the business?

5. What are the roles of a management accountant?

6. What is the skill set required to be possessed by a management accountant?

•BS Accountancy in the Philippines. http://www.finduniversity.ph/majors/bs-in- accountancy-

SM might just be the most recognizable two-letter combination here in the

Three main factors considered by creditors before lending to a company:

The government is likewise a user of a company's financial statements. Does the

Alternatively, researchers study financial statements to identify particular trends in a

Companies undoubtedly affect the whole economy. By continuing to operate,

Management is composed of employees within the company that can implement

1. What areas of the business are becoming problematic?

Predominantly, owners or stockholders want to know if their investments will yield

II. Review Questions

Joselito G. Florendo, copyright 2016, Fundamentals of Accountancy, Business, and

Sole proprietorships, as the name suggests, are businesses formed by a single

Being indistinguishable from the owner, a business operating as a sole proprietorship

Advantages of Sole Proprietorships

2. The owner has full control of the business

3. Owners can mix personal and business assets

4. Owners have all the profits for themselves

Disadvantages of a Sole Proprietorships

Imagine a scenario where a sole proprietorship incurs huge amounts of debt in

2. Difficulty of raising additional capital