CHAPTER 1

THE ACCOUNTING AND BUSINESS

ENVIRONMENT

Learning Outcomes

After reading this chapter, the learners should be able to

1. explain the nature of business, types of business operations,
and legal forms of business organization.
2. define accounting and accounting information;
3. identify the users of accounting information and their
information needs;
4. describe the environment of accounting profession

THE BUSINESS

Business dictionary defines business as an organization or

economic system where goods or services are exchanged for one another
or for money. Business is synonymous to commerce. It involves
interchange of goods, services or commodities.

Generally, business is formed to earn profit. It requires investment

from its owners in forms of cash or other non-cash assets such as property,
or even services. In exchange, the owners will realize the return on
investment which is called profit. However, not all businesses are profit-
oriented. Not-for-profit organizations are not driven by profit but by a
cause which serves as the reason of its existence. Examples are non-profit
hospitals or educational institutions, cooperatives, charity and religious
groups, and non-government organizations.
Chapter 1 – The Accounting and Business Environment

TYPES OF BUSINESS ORGANIZATIONS

Business organizations are classified according to the nature of

operations. Some business offer their service and expertise, others sell
ready-made goods and different merchandise, while others produce their
goods before they sell them to others. The three main types of business
according to the nature of their operations are [1] service business, [2]
merchandising business, and [3] manufacturing business.

Service Provider

A service business is one that provides services to its customers

and earns profit through charging service fees. Service businesses provide
intangible products to its customers. Examples of service companies are
utilities or janitorial companies, restaurants, accounting or auditing firms,
law firms, medical and dental clinics, hair and make-up parlors,
educational institutions, banking, and transportation services.

Merchandising Business

In layman’s term, merchandising business is called “buy-and-sell”

business. A merchandising or trading business is one that buys products
with the intention of reselling the same products without the need for
further processing. Examples of this type of business are convenience and
grocery stores, drugstores, ready-to-wear (RTW) boutiques, and hardware
stores.

There are two classifications of merchandisers: wholesalers and

retailers. Wholesalers buy their products directly from the manufacturers
in bulk or in wholesale and sell them to other wholesalers or retailers.
Retailers, on the other hand, buy their products from manufacturers or
wholesalers and sell them to the consumers.

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Manufacturing Business

A business which buys raw materials and processes the materials

to become saleable goods, is called manufacturing business. This type of
business is the most complicated among the three types of business
because of its conversion process. Conversion process involves the use of
labor and other product costs such as electricity, rent, and depreciation of
machineries used, to transform the raw materials to finished goods.
Examples of manufacturing business are car manufacturing companies,
tailoring business, furniture companies, and shoe companies.

LEGAL FORMS OF BUSINESS ORGANIZATIONS

The legal forms of business describe the characteristics of their

capital structure. Owners, which is a general term to refer to the one who
owns and operates a business enterprise, can be classified into three: a sole
proprietor, a partner, and a shareholder. Hence, the three legal forms of
business are sole proprietorship, partnership and corporation.

Sole Proprietorship

A business organization owned by a single person is called sole

proprietorship. The owner, called the proprietor, contributes the initial
and additional capital, and thus, realizes all business profits. incurs all the
losses, and is liable for all the business obligations. The proprietor may
employ employees and management personnel to assist him in his
functions of operating the business. The single proprietorship is simple in
structure, because the single owner can ultimately make crucial decision
about enterprise operations. For this, it is not heavily regulated and is easy
to organize. In the Philippines, the cost of government permits and
licenses for sole proprietorships are minimal, and there are only a few
regulations and monitoring requirements. To register a sole proprietorship,
one must obtain permits and licenses from Department of Trade and
Industry, Bureau of Internal Revenue, and the Local Government Unit
where the business is located.

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A sole proprietorship is not subject to income taxation. However,

the proprietor shall include in his Income Tax Return the profit derived
from operating the business. The business profit, therefore, forms part of
the owner’s taxable income with a graduated tax rate of 5% to 32%. A
single proprietor, however, takes the risk of exposing his or personal
assets to be overtaken by government or creditors, because a single
proprietor is liable for business debts even to the extent of his personal
assets.

Partnership

A form of business organization in which two or more persons

contribute money, property or industry into a common fund for business
purposes, with the intention of dividing any profit or loss among
themselves by virtue of a contract, is called a partnership. Although this
form of organization is composed of several owners called partners, not
every partner is essentially involved in the management of the partnership.
Various arrangements may be agreed upon for sharing or profits or losses,
limits in the assumption of partner’s liability, and the composition of
management team.

As compared to sole proprietorship, the presence of more owners

in a partnership means better opportunity to generate large amount of
capital and better credit status. Similarly, more prudent decisions are
formulated as partners perform their duties and responsibilities and share
in the decision-making process according to their competencies and areas
of specialization.

Similar to a single proprietorship, a partnership is characterized by

unlimited liability. Each partner is individually liable to pay the
partnership’s obligations, therefore, creditors can run after the partner’s
personal properties. A partnership is also subject to indirect double
taxation. Partnership’s profit is subject to normal corporate income tax,
and the partner’s share in profit is again included in the partner’s
individual income tax return to form part of his personal total taxable

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income. Furthermore, a partnership’s life is limited, because, in

accordance with Philippine laws, it is dissolved by any of the following
causes: death, insolvency, insanity, retirement or incapacity of a partner,
withdrawal of an existing partner, and admission of a new partner. It is
also dissolved by partners’ will.

In the Philippines, partnerships are registered with the Securities

and Exchange Commission (SEC) after submission of the regulatory
requirements. However, failure to register with SEC does not preclude a
partnership to acquire separate juridical personality. As a separate person,
partnership may purchase properties, incur obligations, and bring actions
in court under its name.

Corporation

The third form of business organization is the corporation. A

corporation, as defined in the Corporation Code of the Philippines, is an
artificial being created by operation of law, having the right of succession
and the powers, attributes and properties expressly authorized by law or
incident to its existence. It is a business entity chartered by the
government and is accorded with powers and responsibilities expressly
authorized in its charter or implied by its existence.

A corporation is created when five to fifteen incorporators who are

all natural persons, file the articles of incorporation with the SEC which in
turn will issue a certificate of incorporation valid for fifty years, unless
sooner revoked. The fifty-year period may be extended upon application
of renewal.

The equity holders of a corporation are called shareholders.

Shareholder’s do not directly manage the business operations. They elect
the members of the board of directors who run the affairs of the
corporation. The shareholder’s limited participation in running the
corporation is associated with limited liability. This means that
shareholders are only liable to the corporation’s creditors up to the amount
they paid for their shares.

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Compared to sole proprietorship and partnership, a corporation can

generate substantially larger capital and enjoys longer life. In a public
corporation (corporation whose shares are registered and traded in a
capital market), corporate capital is increased as number of persons who
are willing to invest and buy shares of stocks, also increase, subject to the
limit of the corporation’s authorized shares. Shareholders have the right
of succession, meaning, they can sell their ownership shares without the
consent of the other shareholders.

The involvement of public investors and the corporate

characteristic of limited liability subject the corporations to stricter
regulations by the SEC and other regulatory agencies in order to protect
the interest of the shareholders, the creditors, the customers, and the
general public.

ACCOUNTING AS THE LANGUAGE OF BUSINESS

The American Accounting Association defines accounting as the

process of identifying, measuring and communicating economic
information to permit informed judgment and decision by users of
information. This definition indicates that accounting is a system that
identifies, measures and communicates financial information about a
specific business entity. This financial information will aid the users in
forming economic decisions. In effect, business transactions are analyzed,
recorded, summarized and interpreted so that they are converted into
meaningful accounting information, which is then used by users to make
intelligent economic decisions.

Users of Accounting Information

The users of accounting information are classified into two: [1]

internal users (or the management) and [2] external users.

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Internal users are those who have direct access to financial

information about an enterprise. They use financial or accounting
information to formulate the optimal operating, investing or financing
decisions, which are considered as key business decisions. Internal users
are limited to the management, which includes key managerial employees,
who act as stewards of enterprise resources to provide the best possible
returns to its owners and serve in the best possible way the interest of the
other stakeholders of the enterprise.

Management needs accounting information because intelligible

decisions are based not on raw data but on processed information about
past performance and present financial condition of the enterprise. For
instance, to answer the question “are we going to purchase a new
equipment?” will necessitate the study of the overall financial position and
performance of the company and the possible financial impact on the
overall operations of the entity. Furthermore, financial information helps
identify trends or deviations from trends that aid in making projections
about the future. Because decision needs of the management vary from
one instance to another, the financial information is communicated in
ways that fit the specific needs at a particular time or period. Thus
management accounting information reports are not structured and do not
conform to specific standards. The branch of accounting that serves the
need of the internal users is called Managerial Accounting or Management
Accounting.

Another group of decision makers is the external users. The

external users do not have ready access to financial information about a
business enterprise and therefore rely heavily on structured financial
reports, called financial statements, about an economic entity. Compared
to internal users, external users face the challenge of arriving at optimal
decisions in spite of the lack of firsthand knowledge and more detailed
information about the affairs of the business. Hence, their decisions are
based largely on how they understand and interpret the information
contained in the financial statements. The following are examples of
external users and a description of their information needs.

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1. Investors and potential investors. The investors are the primary

users of accounting information. They are concerned with the return
of their investment in the business. To decide whether to invest or not,
they assess the company’s financial performance and financial
position. In addition to a complete set of financial statements, they
are interested in information such as earnings per share and return on
investment.

2. Creditors, lenders and suppliers. To decide whether a loan should

be granted to the company, creditors need to evaluate the company’s
ability to pay its debts when they become due. As such, they need to
establish whether the company is liquid or solvent. Information about
liquidity, solvency and capital structure are found in the statement of
financial position, while ability to generate cash flows is contained in
the statement of cash flows and statement of comprehensive income.

3. Government units. The government plays an important role in the

any business environment. Its main task is to regulate the activities of
the entity’s under its jurisdiction. Some of the government units
which are more likely interested in the accounting information
provided by business are the Bureau of Internal Revenue (BIR) and
Securities and Exchange Commission (SEC). The BIR as the national
tax authority, uses financial information as the basis for assessing the
company’s tax obligation. On the other hand, the SEC is the country’s
registry of financial records and ensures that public investors have
adequate information.

4. Customers. Customers need financial information to determine

whether the company can continue to supply them the goods they
need. Some customers are dependent on a company’s goods and
supplies, hence they need information that would help them assess the
‘going concern’ status of their suppliers.

5. Employees and labor unions. Although employees are considered

internal to the operations of an entity, they may not have direct access
to the entity’s records. They need accounting information to

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determine whether the company can offer employment tenureship,

possible pay raises, as well as enhanced employee benefits.

6. The public as a whole. The public may wish to assess the effect of an
entity’s operations to the national economy. For example, the entity
may provide employment to the local community or has corporate
social responsibility programs for the society.

To protect the interest of this wider group of users who may not
have immediate opportunity for verification of information, the financial
statements must be prepared in accordance with the prescribed reporting
framework to ensure that such information is both relevant and
representationally faithful.

THE ACCOUNTANCY PROFESSION: PHILIPPINE SETTING

The law regulating the accountancy profession in the country is

Republic Act (R.A.) 9298, which is known as The Philippine
Accountancy Act of 2004. The law provides for and governs the
standardization and regulation of accounting education, the examination
for registration of certified public accountants (CPAs), and the
supervision, control and regulation of the practice of the accountancy
profession in the Philippines.

The practice of the accountancy profession includes the public

practice; practice in commerce and industry; practice in education /
academe; and practice in government.

Public Practice constitutes in a person, be it his/her individual

capacity, or as a partner or as a staff member in an accounting or auditing
firm, holding out himself/herself as one skilled in the knowledge, science
and practice of accounting, and as a qualified person to render professional
services as a certified public accountant, or offering or rendering, or both,
to more than one client on a fee basis or otherwise, services such as audit,
design and installation as well as revision of accounting systems,

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representation of client entities on tax and other related matters, and

professional assistance in matters relating to accounting procedures.

Practice in Commerce and Industry constitutes employment by

an entity, where such employment involves decision making requiring
professional knowledge in the science of accounting as well as the
accounting aspects of finance and taxation or when such employment or
position requires that the holder thereof must be a certified public
accountant. In this connection, any position in any business or company
in the private sector which requires supervising the recording of financial
transactions, preparation of financial statements, coordinating with the
external auditors for the audit of such financial statements and other
related functions shall be occupied only by a duly registered CPA.

Practice in Education/Academe constitutes in a person in an

educational institution which involves teaching of accounting, auditing,
management advisory services, accounting aspect of finance, business
law, taxation, and other technically related courses or subjects. Likewise,
Occupying the position of a dean or the department chairman or its
equivalent that supervises the Bachelors of Science in Accountancy
program of an educational institution is deemed to be in practice of
accountancy in the academe/education. Therefore, such positions must be
occupied only by a duly registered CPA.

Practice in the Government constitutes in a person who holds, or

is appointed to, a position in an accounting professional group in
government or in a government–owned and/or controlled corporation,
including those performing proprietary functions, where decision making
requires professional knowledge in the science of accounting, or where a
civil service eligibility as a certified public accountant is a prerequisite.

In the context of R.A. 9298, a CPA is defined as a person who

holds a valid Certificate of Registration and a valid Professional
Identification Card issued by the Commission upon recommendation by
the Board to those who have satisfactorily complied with all the legal and

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procedural requirements for such issuance, including in appropriate cases,

having passed the CPA licensure examination.

The Professional Regulatory Board of Accountancy

The Professional Regulatory Board of Accountancy (PRBOA),

under the supervision and administrative control of the Professional
Regulation Commission, is the body that regulates the professional
practice of accountancy in the Philippines. The Board is composed of a
chairman and six (6) members all duly appointed by the President of the
Philippines, from a list of nominees submitted by the Philippine Institute
of Certified Public Accountants (PICPA), the accredited national
professional organization of CPAs in the Philippines.

A member of the Board shall, at the time of his/her appointment,

possess the following qualifications:

a. Must be a natural-born citizen and a resident of the Philippines;

b. Must be a duly registered Certified Public Accountant with at least

ten (10) years of work experience in any scope of practice of
accountancy. He/shall be nominated to represent a sector from
which he/she has considerable and meaningful professional
experience;

c. Must be of good moral character and must notth have been

convicted of crimes involving moral turpitude;

d. Must not have any pecuniary interest, directly or indirectly, in any

school, college, university or institution conferring an academic
degree necessary for admission to the practice of accountancy or
where review classes in preparation for the licensure examination
are being offered or conducted, nor shall he/she be a member of
the faculty or administration thereof at the time of his/her
appointment to the Board;

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e. Must not be a Director or Officer of the APO at the time of his

appointment.

Provided, That if the Chairman or any member of the Board is still

in active practice of public accountancy or connected with any office in
commerce and industry or in the government, he/she must go on leave
during the pendency of any case involving himself/herself, his firm,
partnership, company or government office, or inhibit himself/herself
completely in all the stages of the proceedings thereof.

PRBOA is accorded with powers, functions and responsibilities

necessary for the practice of the profession in the Philippines, emanating
from the administration of the licensure examination for CPAs,
registration to the practice, issuance of certificate of registration up to the
eventual revocation and suspension of such certificate. It has also the
responsibility to code of ethics for the practice of accountancy monitor the
conditions affecting the practice of accountancy and adopt such measures,
including promulgation of accounting and auditing standards, rules and
regulations and best practices as may be deemed proper for the
enhancement and maintenance of high professional, ethical, accounting
and auditing standards.

The CPA Licensure Examination

All applicants for registration for the practice of accountancy shall

be required to undergo a licensure examination to be given by the Board.
Any person applying for examination shall establish the following
requisites to the satisfaction of the Board that he/she:

a) is a Filipino citizen;
b) is of good moral character;
c) is a holder of the degree of Bachelor of Science in Accountancy
conferred by a school, college, academy or institute duly
recognized and/or accredited by the CHED or other authorized
government offices; and

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d) has not been convicted of any criminal offense involving moral

turpitude.

The CPA licensure examination shall cover the following courses

(PRBOA Resolution No. 262 Series of 2015 Revisions in the Subjects of
the Board Licensure Examination for Certified Public Accountants):

1. Financial Accounting and Reporting;

2. Advanced Financial Accounting and Reporting;
3. Management Advisory Services;
4. Auditing;
5. Taxation; and
6. Regulatory Framework for Business Restrictions.

To be qualified as having passed the licensure examination for

accountants, a candidate must obtain a general average of seventy-five
percent (75%), with no grades lower than sixty-five percent (65%) in any
given subject. In the event a candidate obtains the rating of seventy-five
percent (75%) and above in at least a majority of subjects, he/she shall
receive a conditional credit for the subjects passed: Provided, that a
candidate shall take an examination in the remaining subjects within two
years from the preceding examination: Provided, further, that if the
candidate fails to obtain at least a general average of seventy-five percent
(75%) and a rating of at least sixty-five percent (65%) in each of the
subjects reexamined, he/she shall be considered as failed in the entire
examination.

DISCUSSION QUESTIONS

1. What characterizes a business? Explain.

2. What are the types of business? Describe the revenue producing
activities of each type.
3. What are the advantages of a corporation over a single
proprietorship and a partnership?

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4. What are the disadvantages of a corporation, compared to a single

proprietorship and a partnership?
5. What is the role of accounting in a business environment?
6. What is

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