Chapter 1: Accounting: The Language of Business 1

C H A P T E R 1
ACCOUNTING: THE LANGUAGE OF BUSINESS

LEARNING OBJECTIVES:

1. Define Accounting and know its purpose

2. Differentiate the types of business organizations
3. Distinguish the different types of business operations
4. Know and appreciate the basic accounting principles used in the practice of
accounting

WHAT IS ACCOUNTING?

Owners and managers need accurate financial information in order to run

their businesses effectively. Accounting is the process by which businesses
record, classify, summarize and interpret this financial information and
communicate it to interested parties. Accounting records provide most of the
information. All types of businesses keep accounting records according to the
generally accepted accounting principles developed to meet the needs of many
users. From these records, accountants assemble financial information following
the steps in accounting cycle, to produce financial statements that are the end
result of the accounting process.

Accounting provides financial information about a business or nonprofit

organization owners, managers, investors and other interested parties need this
information in order to make decisions about a business or an organization.
Because it is used to communicate financial information, accounting is often
called the “language of business”.

ACCCOUNTING as defined by the Committee on Terminology, American Institute

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

THE NEED FOR ACCOUNTING

Human beings have limitations. Everyday transactions cannot be retained

in the human brain for quite a period of time without confusions and
complications. To avoid these, transactions and other important events should
be recorded. Such written records serve as reference for future recall.

In business, several parties are interested to its records to seek answers

to their questions and bases for their decisions. These parties can be classified
into direct users or those who have direct interest to the business records and
indirect users or those who are indirectly interested to accounting information
of the business. Among them are as follows:
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1. INVESTORS / OWNERS / STOCKHOLDERS

- They want to know the financial position and results of operations of
their business investment.

2. GOVERNMENT
- Financial information is important for tax purposes and in compliance
with Securities and Exchange Commission (SEC) requirements.

3. FINANCIAL INSTITUTIONS / CREDITORS

- These parties need financial information to determine the capacity of a
business organization to pay obligations.

4. MANAGEMENT
- Financial information is useful to the management for guidance to future
actions.

5. EMPLOYEES
- They are interested to know if they have a future in the company.

Financial Accounting
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Accounting information based on the illustration is essential in decision-

making process, especially in all business-for-profit organizations; persons at
various level of management make decisions that require accounting
information. These decisions can be classified into four major types:

1. FINANCING DECISIONS – deciding what amounts of capital are needed and

whether it is to be secured from owners or creditors.

2. RESOURCE ALLOCATION DECISIONS – deciding how the total capital of a firm

is to be invested, such as the amount invested in machinery.

3. PRODUCTION DECISIONS – deciding what products are to be produced, by

what means and when.

4. MARKETING DECISIONS – setting selling prices and advertising budgets;

determining where a firm’s markets are and on how can they be
reached.

FOUR PHASES OF ACCOUNTING

1. RECORDING
- technically called as bookkeeping; business transactions are
documented systematically and chronologically in the proper
accounting books.

- 2 KINDS OF BOOKKEEPING:
a. Single Entry bookkeeping
- does not show the two-fold effects of business
transactions; it only shows the debit or credit of each
transaction.
b. Double Entry bookkeeping
- reflects the two-fold effects of business
transactions; it shows both the debit and credit of a
business transaction.

2. CLASSIFYING
- items entered in the recording process (journalizing) are sorted
and group together based on the nature of the transactions such
as asset accounts, liability account, capital account etc.

3. SUMMARIZING
- after each accounting period (fiscal period) data recorded are
summarized through financial statement.

4. INTERPRETING
- due to the technicality of accounting reports, the accountant
interpretation on the financial statements are needed.

Financial Accounting
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FIELDS OF ACCOUNTING

Accounting has the following fields in which an accountant finds himself

employed:

A. PUBLIC ACCOUNTING
- a professional service rendered by a Certified Public Accountant (CPA)
and his employees to the public for a fee which could be any of the
following services:

1. AUDITING - principal service that a CPA offers; examine, test and check
the accuracy of the reports and the financial data from which these
reports were taken from and then expresses his opinion on the fairness of
the audited reports.

2. MANAGEMENT ADVISORY SERVICE – includes the design, installation and

improvements of the firm’s general accounting system and other system
deemed necessary for controlling and distributing manufacturing costs. In
addition, advises on financial planning, budgeting, forecasting and
inventory control.

3. TAX SERVICES - includes preparation and filing of income tax returns

B. PRIVATE ACCOUNTING
- an accounting job done in private business enterprises.

1. GENERAL ACCOUNTING - includes recording transactions and preparing

financial reports for the use of the management, owners, creditors,
governmental units and other interested parties.

2. COST ACCOUNTING – controlling and determining costs particularly those

costs in producing a product or service.

3. BUDGETING – provides management a plan for future operations and

after this plan has been applied, summaries and reports comparing
the actual accomplishments with the plan are provided.
4. INTERNAL AUDITING – see to it that the established accounting
procedures are being followed throughout the year.

5. GOVERNMENT ACCOUNTING – government officials, like private business

firms, rely on accumulated accounting data. Accountants are
responsible for the accumulation of these data. They also check and
audit the income, payroll and tax returns submitted to the
government.

6. ACCOUNTING EDUCATION – faculty members in Accounting in various

colleges and universities are CPA.

7. INTERNATIONAL ACCOUNTING – concerned with the transactions and

special problems of multinational business organizations in their
dealings in the international trade.

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8. SOCIAL ACCOUNTING – involves the measurement of social costs and

benefits such as the measurement of traffic patterns for the most
efficient use of traffic funds.

MAJOR AREAS OF ACCOUNTING

1. FINANCIAL ACCOUNTING – focuses on the development and

communication of financial information for external users

2. MANAGERIAL ACCOUNTING – concerned primarily with financial reporting

for internal users as a basis for decision making

3. GOVERNMENT ACCOUNTING – focuses on the accounting development and

communication of financial affairs of governmental agencies

TYPES OF BUSINESS ORGANIZATION

Business organization can be classified into two: (1) according to

ownership and (2) according to the nature of the business.

A. OWNERSHIP/ORGANIZATION:

Type of Business Entity

Characteristic
Sole Partnership Corporation
Proprietorship

Ownership One owner Two or more Not less than five

Life of the Business Ends when the Ends when one Can continue
owner dies, is or more forever, ends
unable to carry partners only when the
on operations, withdraw, business can no
or decides to when a longer pay its
close the firm. partner dies, creditors and
or when the goes bankrupt or
partners when the
decide to stockholders vote
close the firm. to liquidate it.

Responsibility for Owner is Partners are Stockholders are

debts of the responsible for responsible not responsible
Business firm’s debt individually for firm’s debts;
when firm is and jointly for they can lose
unable to pay firm’s debts only the amount
when firm is of their
unable to pay investment

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B. NATURE OF THE BUSINESS OPERATION

1. SERVICE
- deals with the rendering of services to the customers such as
tailoring shops, beauty shops, firms of CPAs, lawyers, doctors and
other

Illustration: SERVICE CONCERN

Specialized
skills/labor

2. TRADING/MERCHANDISING
- deals with the buying of goods and selling the same goods in the
same form for profit such as sari-sari store, department stores,
grocery stores, etc.

Illustration: MERCHANDISING

Buy Sell

3. MANUFACTURING
- involves purchase of raw materials and converting these raw
materials into finished products such as textile manufacturing
firms, candy manufacturing firms, etc.
Illustration: MANUFACTURING

Processing
Buy
Sell

Financial Accounting