Definition of Accounting

Accounting Standard Council

It is a service activity. Its function is to provide quantitative information, primarily financial in
nature, about economic entities that is intended to be useful in making economic decisions.

American Accounting Association

It is the process of identifying, measuring and communicating economic
information to permit informed judgments and decisions by users of the
information.

American Institute of Certified Public Accountants

It is an art of recording, classifying, summarizing in a significant, manner and in terms of money,
transactions, and events which are, in part at least, of a financial character, and interpreting the
results thereof.

All of the above definitions touch the most important points of

Accounting as:
accounting is about quantitative information
the information is of financial character
usefulness of information in decision making.

Four Phases of Accounting

-Recording -Summarizing
-Classifying -Interpreting

Generally Accepted Accounting Principles

(GAAP)
The preparation of financial statements is governed and guided by Generally Accepted
Accounting
Principles (GAAP). GAAP are uniform set of accounting rules, procedures, practices and
standards that are followed in
preparing the financial statements.
They serve as “ground rules” that guide accounting practitioners in recording, identifying,
analyzing
and measuring) and reporting financial information of a business entity.

Before an accounting principles becomes generally accepted in the practice, it must first meet
with
the following requirements, to wit:
a. it must have been established by a standard-setting body and must have gained world-wide
or
universal acceptance among practitioners;
b. It must have substantial authoritative support from accounting bodies, such as Securities and
Exchange Commissions (SEC), Financial Executive Institute of the Philippines (FINEX), Bangko
Sentral ng Pilipinas (BSP), Board of Accountancy (BOA), Commission on Audit (COA), and other
respectable members of the financial community both locally and internationally.

Some of the Generally Accepted Accounting Principles that are followed and are still
applicable
for use are:

Cost Principle – the principles requires that assets should be recorded at original or acquisition
cost.
Objectivity Principle – this principle requires that accounting records should be based on
reliable and verifiable data as evidence of transactions.
Materiality Principle – this principle dictates practicability to rule over theory in determining the
valuation of an item. To determine whether the item is material or not, it is a matter of
professional judgment on the part of the accountant.
Matching Principle – this is a combined concept of Revenue Recognition and Expense
Recognition Principle. Revenue should be recognized when earned and corresponding expense
should be recognized when incurred during the same period as revenue is earned. Proper
matching of revenue and expense are called for.
Consistency principle – this principle requires that accounting methods and procedures should
be applied on a uniform basis from period to period to achieve comparability in the financial
statements.
Adequate Disclosure Principle – this principle requires that financial statements should be free
from any material misstatement, that if there is any, proper disclosure should be made.

Basic Accounting Assumptions

-It is the very foundations of Generally Accepted Accounting Principles. Without these
accounting assumptions, there could be no uniformity in the practice of accounting which can
only result to having distorted and meaningless financial statements.
1. Accounting Entity
2. Going-Concern
3. Time-period Assumption
4. Unit of Measure
5. Accrual Basis Assumption

What are Financial Statements?

Financial Statements are structured representation of financial position and financial
performance of an entity. The objective of financial statements is to provide information about
the financial position, financial performance, and cash flows of an entity that is useful to a wide
range of users in making sound economic decisions.
It shows the results of the management’s stewardship of the resources entrusted to it.
Financial statements are the “end products” of the accounting process. These refer to the
accountant’s report based on data gathered, accumulated and processed in financial accounting
that are periodically
communicated to the variety of users particularly the owners and creditors.

There are six (6) basic financial statements as per revised PAS No. 1

1.A statement of financial position as the end of the period. (Balance Sheet)
2.A statement of comprehensive income for the period (Income Statement)
3.A statement of changes in equity for the period.
4.A statement of cash flows for the period.
5.Notes, comprising a summary of significant accounting policies and other explanatory, and
6.A statement of financial position as at the beginning of the earliest comparative period when
an entity applies an accounting policy retrospectively or makes a retrospective restatement of
items in its financial statements or when it reclassifies items in its financial statements.

Balance Sheet
-A financial statement which shows the financial position of an enterprise as of a particular
date. It consists of three sections which are the Assets, Liabilities and Owner’s Equity.

The balance sheet measures and evaluates in terms of the enterprise’ liquidity, solvency,
financial structure and capacity maturing obligations.
Liquidity – is the stability of the enterprise to meet currently maturing obligations.
Solvency – the availability of cash over the longer term to meet maturing obligations.
Financial structure – is the source of financing for assets of the enterprise. It indicates how
much is borrowed capital and how much is equity capital.
Capacity for adaptation – is the financial flexibility of the enterprise to use the available cash
for unexpected requirements and investment opportunities.

Basic Accounting Equation

Assets = Liabilities + Owner’s Equity

Income Statement
A financial statement which shows the performance of the enterprise for a given period of time.

The performance of the enterprise is primarily measured in terms of the level of income earned
by the enterprise through effective and efficient utilization of its resources.
The income performance used to be known as the “results of operations” of the enterprise
consisting of revenues, expenses, and operating results which would either be profit or loss.
Formula:
Revenue Pxx
- Expenses xx
=Profit (Loss) Pxx

The information presented in an income statement is usually considered the most important
information
provided by financial accounting because profitability is a paramount concern to those
interested in the
economic activities of the enterprise.

Expanded Accounting Equation

Assets = Liabilities + Owner’s Equity (+ Revenue – Expenses)

Statement of Changes in Owner’s Equity

A financial statement that summarizes the changes in equity for a given period of time. The
beginning equity of the owner is increased by the additional investment and profit. It is
decreased by withdrawal and loss.

Elements of Financial Statements and Account Titles Used

The elements that are directly related to measurement of financial condition in the balance
sheet are assets, liabilities and owner’s equity while the elements that are directly related
measurement of performance in the income statement are income and expenses. These
accounting elements are given account names or account
titles.

Balance Sheet Accounts

Assets are defined as “resources controlled by the enterprise as a result of past transactions and
events and from which future economic benefits that are expected to flow the enterprise.
The following are the essential characteristics of an asset:
a. the asset is controlled by the enterprise.
b. the asset is a result of a past transaction or event.

c. the asset provides future economic benefit.

d. the cost of the asset can be reliably measured.

Classification of Assets
Current assets – refers to all assets that are expected to be realized, sold or consumed within
the enterprise’s normal operating cycle. Operating cycle is the interval of time from the date of
acquisition of merchandise inventory, sell the inventory to customer and the ultimate collection
of cash from the sale. When the normal operating cycle of the business is not clearly
identifiable, it is assumed to be twelve months.

a. Cash – the account title to describe money, either in paper or in coins and money substitutes
like check, postal money orders, bank drafts and treasury warrants.
b. Cash equivalents – PAS No. 7 defines cash equivalents as short term, highly liquid instruments
that are readily convertible into cash and they present insignificant risk of changes in values
because of changes in interest rates.
c. Petty cash fund – the account title for money placed and set aside for petty or small expenses.
d. Notes receivable – this a promissory note that is received by the business from the customer
arising from rendering of services, sale of merchandise, etc.
e. Accounts Receivable – the account title for amounts collectible arising from services rendered
to a customer or client on credit or sale of goods to customers on accounts. This constitutes an
oral or verbal promise to pay by a customer or client.
f. Estimated Uncollectible Accounts – this is an asset offset or a contra-asset account. It provides
for possible losses from uncollected accounts. Although, this is not actually an asset, it is
classified as such because it is shown as a deduction from the Accounts Receivable which is a
Current Asset Account. The difference between accounts receivable and the related estimated
uncollectible accounts is called Estimated Realizable Value.
g. Accrued income – the amount of income earned but not yet collected.
h. Advances to Employees – the account title for amounts collectible from employees for
allowing them to make cash advances which are deductible against their salaries or wages.
g. Inventories – Per PAS No. 2 these are assets which are (1) held for sale in the ordinary course
of business; (2) in the process of production for such sale; or (3) in the form of materials or
supplies to be consumed in the production
process or in the rendering of services.
h. Prepaid Expenses – account title for expenses that are paid in advance but are not yet
incurred or have not yet expired such as Prepaid Rental and others.
i. Unused supplies – an account title for cost of stationery and other supplies purchased for use
but are left on hand and still unused.

Non-Current Assets – “all other assets not classified as current should be classified as non-
current
assets”.
1. Property and Equipment – PAS No. 16 defines property and equipment as “tangible assets
which are held by an enterprise for use in production or supply of goods and services, for rental
to others, or for administrative purposes, and which are expected to be used during more than
one period.

2. Land – an account title for the site where the building used as office or store is constructed.
Land is not subject to depreciation because it is expected to be useful to business enterprise for
indefinite period of time.
3. Building – account title for a finished construction owned by the business where operations
and transactions took place.
4. Equipment – includes calculators, typewriters, adding machines, computers, steel filing
cabinets and the like.
5. Furniture & Fixtures – includes chairs, tables, counters, display cases and the like.
6. Accumulated depreciation – this is an asset offset or contra-asset account. This is called a
Valuation Account which is shown as a deduction from property and equipment.
7. Intangible Assets – Per PAS No. 38, these are identifiable non-monetary assets without
physical existence. Examples arepatents, copyright, franchise, trademarks, etc.

Liabilities
Defined as “present obligations of an enterprise arising from past transactions or events, the
settlement of which is expected to result in an outflow from the enterprise of resources
embodying economic benefits. It denotes financial obligations of the business to its creditors. It
represents the claim of the creditors over the assets of the enterprise.
The following are the essential characteristics of a liability:
a. The liability is the present obligation of a particular enterprise. This means that the
enterprise’ liability must be identified;
b. The liability arises from past transactions or events. This means that the liability is not
recognized until it is incurred.
c. The settlement of the liability requires an outflow of resources embodying economic benefits.
This means that the obligation of the enterprise is to transfer cash and non-cash resources or
provide services at some future time.

PAS No. 1 liabilities are classified into two namely: current liabilities and non-current
liabilities:

Current Liabilities – are financial obligations of the enterprise which are (a) expected to be
settled in the normal course of the operating cycle; (b) due
to be settled within one year from the balance sheet date.
1. Accounts payable – an account title for a financial obligation of an enterprise that constitutes
an oral or verbal promise to pay.
2. Notes payable (short term) – same as Accounts payable in nature but only the obligation is
evidenced by a promissory note. The enterprise is the one who issue the note.
3. Accrued Expenses – these are expenses incurred by the enterprise but are not yet paid.
4. Pre-collected or Unearned Income – this is an account title for an income collected or
received in advance and is not yet considered as earned.

Non-current liabilities – are financial long term obligations of the enterprise which are due and
payable for more than one year.

Notes payable (long-term) – same nature with that of Notes Payable (short-term) but only, this
requires payment for more than a year.
Mortgage Payable – a financial obligation of the enterprise which requires a fixed or tangible
property to be pledged as a collateral to ensure payment.
Owner’s Equity or Capital
It is the residual interest in the assets of the enterprise after deducting all its liabilities. It is
expressed in the equation as Assets less Liabilities equals Owner’s Equity or Capital.

Withdrawal
The owner’s withdrawal is likewise indicated by the use of the owner’s name with the word
Drawing or Personal written after the name which is separated by a comma.

Income and Expense Summary

These are the temporary account created at the end of the accounting period where Income
and Expense are temporarily closed to this account.

Income Statements Accounts (Temporary Accounts)

Revenues and Expenses – these are the temporary accounts of Owner’s Equity and are also the
components of an Income Statement, a financial statement which directly relates to the
measurement of performance (previously termed as a result of operation) of an enterprise at
the end of a given period of time.

Income or Revenue
PAS No. 28 defines revenues as the “gross inflow of economic benefits during the period arising
in the course of ordinary activities of an enterprise when those inflows result in increase in
equity, other than those relating to contributions from owners.
Examples:
1. Proceeds from services rendered by a servicing firm
2. Income from use by other entities of the resources of the enterprise like royalties income,
rent income and interest income.
3. sale of merchandise by a trading firm

Service Income – an account title used for all types of income derived from
rendering of services.
Other specific income account titles used are:
a. Professional Income – the account title used by professionals for income earned from the
practice of their profession or may be specified as Accounting or Auditing Fees for Accountants,
Legal Fess Income for Lawyers, Dental Fees
Income for Dentists, Medical Fees income for Doctors
b. Rental Income – for income earned on buildings, space or other properties owned and rented
out by the business as the main line of its activity.
c. Interest Income – for income received by the business arising from an amount of money
borrowed by a customer and is usually covered by a promissory note.

Expenses
The “gross outflow of economic benefits during the period arising in the course of ordinary
activities of an enterprise when those outflow result in decrease in equity, other than those
relating to distribution to owner”.
Examples:
1. salaries expense
2. rent expense
3. stationery and supplies expense
4. uncollectible accounts
5. depreciation
6. taxes and licenses

Profit(Loss)

The excess of revenues over expenses is called “Profit”. If expenses exceed the revenues, it is
called a “Loss”.

Interest Expense – an expense incurred from borrowed money.

Rent Expense – for the amount paid or incurred for use of property, usually premises.
Repairs and Maintenance – for expenses incurred in repairing or servicing the buildings,
machineries, vehicles, equipment which are owned by the business.
Stationery and Office Supplies expense – the stationery, envelopes, clips, fasteners, etc used in
the office will bear the account title as Office Supplies.
Salaries Expense – for compensation given to employees of a business.
Uncollectible accounts – for the anticipated loss that the business may incur arising from
uncollectible accounts.
Depreciation Expense – for the portion of the cost of property and equipment or fixed assets
that has expired based on rational and systematic allocation procedure.
Amortization Expense – the expired or expense portion of an intangible asset.
Taxes and Licenses – for the amount paid for business permits, licenses and other government
dues.

Insurance Expense – account title for the expired portion of the insurance premium paid.
Utilities expense – the account title for telephone, light and water bills.
Gas & Oil – the account title for gasoline, diesoline, lubricants, grease, fluids, lube oils.
Miscellaneous Expense – any amount paid as expense which is not significant enough to
warrant a particular classification.

What are the Career Opportunities of an Accountant?

Once we become accountants, the several opportunities are the following:

1. Public Accounting - under this field, we are in public practice. As a public practitioner, we
have two options to choose from its either individual practitioners and join partnership with
other individual practitioners.
2. Government Accounting – under this field, we render services to government.
3. Private Accounting – under this field, we will gain employment in private firms and hold
positions as Chief Accountant, Accounting Manager, Internal Auditor and others.
4. Accounting Education – these are CPAs who join in the academe and sacrifice the high income
generating profession for the sake of love in accounting education.

Code of Professional Ethics for CPAs in the Philippines

Being a member of International Federation of Accountants (IFAC), it is commented to observe

the following
fundamental principles,
1. Integrity – A professional accountant should be straightforward and honest in all professional
and business relationships. It implies fair dealing and truthfulness.
2. Objectivity – A professional accountant should not allow bias, conflict of interest or under
influence of others to override professional or business judgments.
3. Professional Competence and Due – A professional accountant has a continuing duty to
maintain professional knowledge and skill at a level required to ensure that a client or employer
receives competent professional service based on current developments in practice, legislation
and techniques.
4. Confidentiality – A professional accountant should respect the confidentiality of information
acquired as a result of professional and business relationships and should not disclose any such
information to third parties without proper and specific authority unless there is a legal or
professional right or duty to disclose.
5. Professional behavior – A professional accountant should comply with relevant laws and
regulations and should avoid any action that discredits the profession.

When Do Accountants Prepare the FinancialStatements?

The business has a continuous life of existence. When it starts, it is assumed that it will continue
to operate for an indefinite period of time. This is the continuity or going concern assumption in
accounting.
The life of the business is then divided into equal periods wherein at the end of each period,
financial statements are prepared, this is referred to as “Accounting Periods”. This is the
periodicity or time period assumption in accounting.

Three (3) Annual Accounting Periods

1. Calendar Year – the accounting period will begin on January 1 and will end on December 31
of the same year.
2. Fiscal Year - the accounting period will begin on the first day of any month of the year except
January and will end on the last day of the twelfth month completing the one year period.
3. Natural Business Year - is a twelve month period that ends on any month when the business
is at the lowest or experiencing slack season. Example, a fiscal year for the hotel industry where
the start is the point of slack in visitors and ends up at its peak season.

Qualities that Financial Statements should possess

Understandability –this means that financial statements should be prepared and presented in a
way that it can be understood by the users.
Reliability - financial information should carry the degree of “confidence” when used by
interested parties. To be reliable, it must be “free from material error” that will lead to material
misstatement, it must be fairly presented and must be free from bias.
a. Faithful representation – the information shows what it purports to show. The accountants
should properly report the actual events and their respective amounts in the financial
statements as objectively possible.
b. Neutrality – financial reports should be fairly presented and must be free from bias. It must
be directed towards the common interest of the users.
c. Conservatism – under this doctrine, when alternatives exist, the alternative which has the
least effect on owner’s equity should be chosen
d. Completeness – financial statements is said to be complete if it contains full disclosure of
significant information necessary in order that the statement would not be misleading. Financial
Statements should also contain notes and supplementary schedules and other information.
e. Substance over form – financial accounting emphasis the economic substance of events even
though the legal form may differ from the economic substance and suggest different treatment.

Relevance – this means that financial statements are prepared intended to help users make
informed economic decisions.
a. materiality – there is no strict rule in determining whether an item is material or not. Very
often, this is dependent on judgment and common sense.
b. predictive value – the financial information enables the users to forecast and make
predictions about the outcome of the future events.
c. feedback value – the financial information enables users to confirm past prediction or correct
earlier prediction.
d. timeliness – the financial information must be available at the time of need or else it will
defeat the purpose.

Comparability – this means that the financial statements prepared are worth comparing for
with other companies of the same line of business by pointing out similarities and differences.
Consistency – once a method or practice is selected from alternatives, it should be followed
from period to period.
Types of Accounting Information

Financial Accounting – it deals primarily with traditional recording of financial transactions

which would eventually result to the preparation of general-purpose financial statements
intended for investors, creditors, government agencies, etc as compared to specific-purpose
financial statements which are needed by management to guide them in the decision-making
process for the company.
Auditing - these are classified into two: Internal and external auditing
Internal auditing – it sees to it that the established accounting procedures are being followed
throughout the year, it determines strict adherence to management policies and measures the
efficiency of operations. These are usually performed by its own employees or staff of the
company.
External auditing – it is performed by an independent professional accountant, who critically
examines the books of accounts and renders an opinion on the fairness of financial statements
being examined.
Management Accounting – it primarily focuses on the gathering of financial informative data
intended against the budget and makes analysis of the variance.
Tax Accounting – involves the preparation of income tax returns and the determination of
correct amount of taxes due and payable to the government.
Financial Management – this is a new type of accounting information wherein its primary
concern is to set up financial planning objectives-including the sources and application of its
resources beneficial to the economic entity.
Cost Accounting – it is concerned primarily with gathering, accumulation and control to
determine the cost of production of goods and services and setting-up the selling price
thereafter.
Government Accounting – deals primarily on the proper custody of public funds in both national
and local government, such as cities, provinces, municipalities and barangays.

Users of Financial Statements

Internal users – refer to the owners or managers who take the responsibility in managing
efficiently and effectivity of the business entity. They take control of the inflows and outflows of
all economic activities including the preparation of financial reports.
External users – refer to those group of users who do not have any access in managing the affair
of the business and are totally dependent on financial reports submitted by the management.
Investors – They need information to help them determine whether they should buy, hold and
sell. Shareholders are also interested in information which enable them to assess the ability of
the enterprise to pay dividends.
Employees – They are interested in information in information about the stability and
profitability of the enterprise. They are interested in information which enables them to assess
the ability of the enterprise to provide remuneration retirement benefits and employment
opportunities.

Lenders – They are interested in information which enable them to determine whether their
loans and interest thereon will be paid when due.
Suppliers and other trade creditors – These users are interested in information which enable
them to determine whether amounts owing to them will be paid on maturity.
Customers – They are interest in information about the continuance of an enterprise especially
when they have a long-term involvement with or are dependent on the enterprise.
Government and their agencies – These users require information to regulate the activities of
the enterprise, determine taxation policies and as a basis for national income and similar
statistics.
Public – Enterprises affect members of the public in a variety ofways. For example, enterprises
make substantial contributions to the local economy in many ways including the number of
people they employ and their patronage of local suppliers.

Nature of Business
Service Concern – the business derived its income from services rendered to clients in case of
professional services, like that of Accountants, Lawyers, Doctors, Dentists, etc., or to customers
in the case of non professional services, like that of a hotel where rental is the main line of their
business.
Merchandising – the business is engaged in buying goods or commodities or any form of
finished products and sells them at a profit.
Manufacturing – the business is engaged in buying of raw materials and supplies to be
processed or manufactured, converting them into finished products for sale at a profit, like that
of furniture shop.
Agriculture – the business is engaged in buying and selling of agricultural products.
Hybrid Companies – those involved in more than one type of activity which are manufacturing,
merchandising and service.
Forms of Business Organization and their Capital Structures

Single or Sole Proprietorship – the simplest form of business organization where capital is
owned and provided by one person called proprietor, who may engage the business by himself
or hire another person to do so.
Partnership – this is form by two or more persons called “Partners” who set forth agreements
among themselves on how profit and losses are divided.
Corporation – this is the biggest and most complicated form of business organization. It is
formed by any person, partnership, association or corporation, singly or jointly with others but
not more than fifteen in number.
Cooperatives – this is formed by fifteen (15) or more natural persons who are Filipino citizen of
legal age, having a common bond of interest and are actually residing or working in the
intended area ofoperation. It operates the same with corporation.