ACT 110

MODULE 1 – CONCEPTUAL FRAMEWORK AND ACCOUNTING PRINCIPLES

INTRODUCTION
Accounting is often called the language of business because it is widely used in describing all
types of business activities. Every investor, manager, and business decision maker need a clear
understanding of accounting terms and concepts if he is to participate and communicate
effectively in the business community.
Everybody should know that the use of accounting information is not limited only to the business
world. We live in an era of accountability. An individual must account for his or her income and
must file income tax returns. Very often, an individual must supply personal accounting
information in order to qualify for a loan, for a scholarship or to obtain a credit card and the like.
Accounting is just as important to the successful operation of a government, social program, or a
church as it is to a business organization.
Therefore, the study of accounting should not be limited to students of business accountancy.
Everyone who engages in economic activities, which means everyone, will benefit from
understanding the nature, significance and limitations of accounting information.

HISTORY OF ACCOUNTING
Accounting as it exists today may have its beginning in Italy in the early part of the 15 th century.
As early as 1341, the Medici family used a set of books consisting of cash book, a stock book, an
age book, and a book of income and outgo.
In 1949, Luca Pacioli, a Franciscan monk and mathematician, published book, “Summa de
Arithmetica, geometrica, proportioni et proportionalita” (everything about arithmetic, geometry
and proportion), containing a section on record keeping. It is the first record book in accounting.
For the next 100 to 200 years, European writers followed Pacioli’s writings.
In 1543, an English bookkeeper, Hugh, wrote treatise on accounting.
In 1581, the first accounting association was formed in Italy. History shows that the double-entry
bookkeeping started in Italy during the renaissance which includes an awakening of an interest in
trade. The expanding trade, specifically through joint ventures involving voyages, required large
investments. Inventors insisted in records being kept of their investments in the ventures.
In the Philippines, the accountancy profession was given a formal recognition on March 17, 1923
when the government enacted a law to regulate the practice of accountancy in the Philippines.
Since then, many amendments were made until P.D. 692 was issued. This is known as the
Revised Accountancy Law.
At present, the law governing the practice of accountancy in the Philippines is known as the
Philippine Accountancy Act of 2004.
NATURE OF ACCOUNTING
What is accounting? The dictionary (Webster’s) defines accounting as the system of recording
and summarizing business and financial transactions and analyzing, verifying, and reporting the
results.
The Committee on Terminology of the American Institute of Accountants defines accounting as
an art of recording, classifying, summarizing, in a significant manner and in terms of money,
transactions and events which are part, at least, of a financial character and interpreting the
results thereof.
The above definition mentions four different functions.
1. Recording – means the setting down in writing accountable transactions and events on
the books or records of the business. Such is usually done on a systemic and
chronological order. Systematic recording means the adherence to specific guidelines,
rules and principles while chronological recording means the sequential recording of
transactions or events by their dates of occurrence.

2. Classifying – means categorizing similar items into the same group or same name based
on certain characteristics or bases for better management of the business. Classifications
may be based on liquidity, permanent nature or other distinctions.

3. Summarizing – means aggregating and creating a condensed version of the recorded and
classified information covering all relevant points for periodic reporting of business
status. This is usually done annually, semi-annually, quarterly, monthly, or as required by
the users of the information.

4. Interpreting – means the explanation, in understandable terms, of the data recorded,

classified and summarized. This involves the provision of assistance by the accountant
through preparation of reports and explanations to aid understanding considering that
accounting is a highly technical and specialized field.

The accounting profession has its own definition of accounting as follows: “Accounting 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.”
Quantitative refers to numbers, that is, the measurement of quantity or amount.
Actually, accounting is an information system that measures business activities, processes the
information into reports, and communicates the reports to the users or decision makers.
PRINCIPAL COMPONENTS OF ACCOUNTING PROCESS
Accounting process is the accumulation and analysis of relevant information and the eventual
report preparation to intended users. It has the following components:
Identifying

This component of the accounting process is the recognition or non-recognition of business

activities as accountable events. Remember that not all business activities are accountable. An
event if it has an effect on the economic resources and/or economic obligations of the business.

Measuring

If the event is identified to have an effect on the economic resources and/or economic obligations
of the business, the next question is, by how much?
This component of accounting process is the assigning of peso amounts to the accountable
transactions and events. It is the expression of the economic impact of the event in peso terms.
Communicating
This component of the accounting process is the preparation and distribution of accounting
reports to users of accounting information. This is the reason why accounting has been called the
language of business.
Implicit in the communication process are the recording, classifying, and summarizing aspects of
accounting. The accounting reports referred to above are called financial statements.

FORMS OF BUSINESS ORGANIZATION

1. Classification of business organizations as to ownership

Sole or Single Proprietorship

A sole or single proprietorship is a form of business organization owned by only one
individual. The individual is referred to as a sole or proprietor.

Generally, the owner acts as the active manager. He may supply the capital from his
personal funds or borrow from other parties.

Partnership
Article 1767 of the New Civil Code of the Philippines defines partnership as “an
association of two or more persons who bind themselves to contribute money, property or
industry to a common fund, with the intention of dividing the profits among themselves.”
Two or more persons may also form a partnership for the exercise of a profession.

A partnership is a legal relationship among contracting parties. This relation originates

from a voluntary contract between them. The partnership contract may be oral or in
 writing, or simply implied from the acts of the parties, as long as the element of the
mutual contribution and intent to divide the profits are present.

Corporation
The Corporation Code of the Philippines defines a corporation as “an artificial being
created by the operation of law, having the right of succession, and the powers, attributes
and properties expressly authorized by law or incident to its existence.”

Five or more persons are required to organize a corporation. The ownership is divided
into shares of stocks. The owners of the corporation are called stockholders or
shareholders.

Cooperatives
It is a business organization which is more of being service oriented. It is similar to a
corporation. It has its Board of Directors selected from among its members who have
equal share in the cooperative. Patronage refunds are given to cooperative members who
patronized the business activities. It also distribute dividends to its members.

2. Classification of business organizations according to activity

Service
Service enterprises are those engaged in rendering services like repair shops, security
agencies, janitorial agencies, laundry shops, beauty parlors, dental clinics, massage
parlors, accounting firms, etc.

Merchandising
Merchandising or trading firms are those companies engaged in purchasing goods that are
ready to be sold and resells these goods to customers without altering or changing the
products. Examples of these are supermarkets, department stores and the like.

Manufacturing
Manufacturing firms are engaged in the manufacture of finished products. These
businesses buy raw materials and transformed them into finished product. Examples of
these are candy makers, hallow-block manufacturers, furniture factories, garment
factories, etc.

Agriculture
Agriculture is a business engaged in planting crops and sells its products either in raw or
finished form at a profit.

THE ACCOUNTANCY PROFESSION

In March 17, 1923, the accountancy profession was given its formal recognition by the
Philippine government by enacting the law to regulate the practice of accountancy. Since then,
accountancy has developed as a profession attaining a status equivalent to that of law and
medicine. In the Philippines, in order to qualify to practice the accountancy profession, a person
must be a graduate of the degree of Bachelor of science in Accountancy and pass a government
examination. The examination referred to is the Certified Public Accountants’ Licensure
Examination also known as the CPA board Examination given by the Professional Regulatory
Board of Accountancy.
The Professional Regulatory Board of Accountancy is the body authorized by law to promulgate
rules and regulations concerning the practice of the accountancy profession in the Philippines.

ACCREDITATION TO PRACTICE PUBLIC ACCOUNTANCY

CPAs in public accountancy who want to practice under individual capacity, firm (sole
proprietorship) or partnership, shall first register with the Board of Accountancy and
Professional Regulations Commissions.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

Accounting has evolved through time changing with the needs of society. As new types of
transactions occur in trade and commerce, accountants develop rules and procedures for
recording them. These accounting rules, procedures and practices came to be known as
generally accepted accounting principles or simply GAAP.
Generally accepted accounting principles encompass the conventions, rules and procedures,
necessary to define what accepted accounting practice is. Generally accepted accounting
principles are conventional, meaning, they become generally accepted by agreement often
tacit agreement rather than by formal derivation from a set of postulates and basic concepts.
The principles have developed on the basis of experience, reason, custom, usage and
practical necessity.
Simply stated, generally accepted accounting principles represent the “rules, procedures,
practice and standards followed in the preparation and presentation of financial statements.”
Generally accepted accounting principles are like laws that must be followed in financial
reporting.
The process of establishing GAAP is a social process which incorporates political actions of
various interested user groups as well as professional judgment, logic and research.

PURPOSE OF ACCOUNTING STANDARDS

 The overall purpose of accounting standards is to identify proper accounting practices for the
preparation and presentation of financial statements.
Accounting standards create a common understanding between preparers and users of
financial statements particularly on how items, for example the valuation of assets, are
treated. Financial statements shall therefore comply with all applicable accounting standards.
FINANCIAL REPORTING STANDARDS COUNCIL
In the Philippines, the development of generally accepted accounting principles is formalized
initially through the creation of the Accounting Standards Council or ASC. The accounting
standards promulgated by the Accounting Standards Council constitute the generally
accepted accounting principles in the Philippines.
The approved statements of the ASC were called “Statements of Financial Accounting
Standards or SFAS.”
Then, the Financial Reporting Standards Council or FRSC replaced the Accounting
Standards Council.
The FRSC is the accounting standard setting body created by the Professional Regulation
Commission upon recommendation of the Board of Accountancy to assist the Board of
Accountancy in carrying out its powers and functions provided under R.A. No. 9298.
The main function is to establish and improve accounting standards that will be generally
accepted in the Philippines.
The approved Statements of Financial Accounting Standards are now known as Philippine
Accounting Standards or PAS and Philippine Financial Reporting Standards or PFRS.

INTERNATIONAL ACCOUNTING STANDARDS COMMITTEE

The International Accounting Standards Committee or IASC is an independent private sector
body with the objective of achieving uniformity in the accounting principles which are used
by businesses and other organizations for financial reporting around the world.
It was formed in June 1973 through an agreement made by professional accountancy bodies
from Australia, Canada, France, Germany, Japan, Mexico, Netherlands, United Kingdom,
Ireland, and the United States of America.
The IASC subsequently expanded to include representatives from over 100 countries and by
year 2000, the membership included 143 professional accounting bodies in 104 countries
representing over two million accountants. The IASC is headquartered in London, United
Kingdom.

Objectives of IASC
1. To formulate and publish in the public interest accounting standards to be observed in the
presentation of financial statements and to promote their worldwide acceptance and
observance.
2. To work generally for the improvement and harmonization of regulations, accounting
standards, and procedures relating to the presentation of financial statements.

Move toward IAS

In the past decades, Philippine accounting standards were mostly patterned after American
Standards.
At present, however, the Philippines (through the FRSC) has totally moved to International
Accounting Standards and International Financial Reporting Standards.
The following factors are considered in deciding to move totally to International Accounting
Standards:
a. Support of International Accounting Standards by Philippine organizations, such as
Philippine SEC, Board of Accountancy and PICPA.
b. Increasing internationalization of business which has heightened interest in a common
language for financial reporting.
c. Improvement of international accounting standards or removal of free choices of
accounting treatments.
d. Increasing recognition of international accounting standards by the World Bank, Asian
Development Bank and World Trade Organization.

INTERNATIONAL ACCOUNTING STANDARDS BOARD

The International Accounting Standards Board or IASB now replaces the International
Accounting Standards Committee or IASC. The IASB publishes its standards in a series of
pronouncements called “International Financial Reporting Standards” or IFRS. However, it
has adopted the body of standards issued by the IASC. The pronouncements of the IASC
continue to be designated as “International Accounting Standards” or IAS.
The IASB’s objective is to raise the quality and consistency of financial reporting and to have
a platform of high quality and improved standards.
The IFRS is a global phenomenon intended to bring about greater transparency and a higher
degree of comparability in financial reporting, both of which will benefit the investors and are
essential to achieve the goal of one uniform and globally accepted financial reporting
standards.
QUALITATIVE CHARACTERISCTICS OF INFORMATION IN FINANCIAL
STATEMENTS
Qualitative characteristics of financial information and other factors considered in the
preparation of financial statements are as follows:
1. Fundamental qualitative characteristics
2. Enhancing qualitative characteristics
3. Accounting conventions
4. Ethical financial reporting

FUNDAMENTAL QUALITATIVE CHARACTERISTICS

The fundamental qualitative characteristics pertain to the content or substance of the financial
information.
Relevance
The information provided in financial statements must be relevant to the decision-making
needs of users. Information has the quality of relevance when it is capable of influencing the
economic decisions of users by helping them evaluate past, present, or future events or
confirming, or correcting, their past evaluations. This means that the information must have a
direct bearing on a decision.
Elements of Relevance
A. Predictive value – Information has predictive value if it helps decision makers predict
certain outcome. For example, cash budgets provide valuable insight as to whether a
company would fall short of cash or not thus whether it has to seek additional financing.
B. Confirmative value – Information has confirmative value if it confirms or changes
previous evaluations. For example, the income statement provides information as to
whether or not a company met earnings expectations.
C. Materiality – Information is material (and therefore has relevance) if its omission or
misstatement could influence the economic decisions of users made on the basis of the
financial statements. It is related to both the nature of an item and its size or misstatement.
Immaterial items are not relevant to the economic decision. The materiality of an item
normally is determined by relating its peso value to an element of the financial statements,
such as net income or total assets.

Faithful Representation
Is the truthful expression in the financial statements of what really happened or existed.
Elements of Faithful Representation
A. Completeness – Complete information provides all information necessary for a reliable
decision. To be reliable, the information in financial statements must be complete within
the bounds of materiality and cost. An omission can cause to be false or misleading and
thus unreliable and deficient in terms of its relevance.
B. Neutrality – Neutral information is free from bias intended to achieve a certain result or
to bring about a particular behavior.
C. Free from material error – To be free from material error means information meets a
minimum level of accuracy so it does not distort what is being reported. Free from
material error does not mean that information is absolutely accurate because most
financial information is based on estimates and judgments.

If major uncertainties about faithful representation exist, they should be disclosed in a

note to the financial statements.

ENHANCING QUALITATIVE CHARACTERESTICS

Enhancing qualitative characteristics pertain to the form or presentation of the financial
information.
Comparability
Users must be able to compare the financial statements of an entity through time to identify
trends in its financial position and performance. Users must also be able to compare the financial
statements of different entities to evaluate their relative financial position, performance and cash
flows. Hence, the measurement and display of the financial effects of lie transactions and other
events and conditions must be carried out in a consistent way throughout an entity and overtime
for that entity, and in a consistent way across entities.
In addition, users must be informed of the accounting policies employed in the preparation of the
financial statements, and of any changes in those policies and the effects of such changes.
Verifiability
Is the quality that different knowledgeable and independent observers could reach consensus,
although not necessarily complete agreement, that a particular depiction is a faithful
representation.
Timeliness
Timeliness involves providing the information within the decision time frame. If there is undue
delay in the reporting of information, it may lose its relevance. Management may need to balance
the relative merits of timely reporting and the provision of reliable information. In achieving a
balance between relevance and reliability, the overriding consideration is how to best satisfy the
needs of users in making economic decisions.
Understandability
The information provided in the financial statements should be presented in a way that makes it
comprehensible by users who have reasonable knowledge of business and economic activities
and accounting and a willingness to study the information with reasonable diligence. However,
the need for understandability does not allow relevant information to be omitted on the grounds
that it may be too difficult for some users to understand.

ACCOUNTING CONVENTIONS
For accounting information to be understandable, accountants must prepare financial statements
in accordance with accepted practices, which includes some concepts that are not formally part
of the agreed-upon conceptual framework and which may conflict with it at times. Familiarity
with the accounting conventions or constraints used in preparing financial statements enables the
user to better understand accounting information.

Consistency
Consistency requires that once a company has adopted an accounting procedure, it must use it
from one period to the next unless a note to the financial statements informs users of a change.
Full Disclosure (Transparency)
Full disclosure or transparency requires that the financial statements present all the information
relevant to users’ understanding of the statements. The statements must include any explanation
needed to keep them from being misleading. For instance, the notes should disclose any change
that a company has made in its accounting procedures.
For example, suppose that a firm has purchased a piece of land for a future subdivision. Shortly
after the end of its fiscal year, the firm is ordered to halt construction because the Environmental
Protection Agency asserts that the land was once a toxic waste dump. This information, which
obviously affects the users of the financial statements, must be disclosed in the statements for the
fiscal year just ended.
Conservatism or Prudence
The uncertainties that inevitably surround many events and circumstances are acknowledged by
the disclosure of their nature and extent by the exercise of prudence in the preparation of the
financial statements.
Prudence is the inclusion of a degree of caution in the exercise of the judgments needed in
making the estimates required under conditions of uncertainty, such that assets or income are not
overstated and liabilities or expenses are not understated. However, the exercise of prudence
does not allow the deliberate understatement of assets or income, or the deliberate overstatement
of liabilities or expenses. In short, prudence or conservatism does not permit bias.
OTHER CONCEPTS INVOLVING FINANCIAL INFORMATION
Substance over form
Transactions and other events and conditions should be accounted for and presented in
accordance with their substance and not merely their legal form. This enhances the reliability of
financial statements.
Substance over form concept entails the use of judgment on the part of the preparers of the
financial statements in order for them to derive the business sense from the transactions and
events and to present them in a manner that best reflects their true essence. Whereas legal aspects
of transactions and events are of great importance, they may have to be disregarded at times in
order to provide more useful and relevant information to the users of financial statements.
Cost-Benefit Analysis
The benefits derived from information should exceed the cost of providing it. The evaluation of
benefits and costs is substantially a judgmental process. Furthermore, the costs are not
necessarily borne by those users who enjoy the benefits, and often the benefits of the information
are enjoyed by a broad range of external users.
Financial reporting information helps capital providers make better decisions, which results in
more efficient functioning of capital markets and a lower cost of capital for the economy as a
whole.
Individual entities also enjoy benefits, including improved access to capital markets, favorable
effect on public relations, and perhaps lower costs of capital. The benefits may also include
better management decisions because financial information used internally is often based at least
partly on information prepared for general-purpose financial reporting purposes.

CONCEPTUAL FRAMEWORK AND UNDERLYING ASSUMPTIONS

The Conceptual Framework is a summary of the terms and concepts that underlie the preparation
and presentation of financial statements for external users. It is an attempt to provide an overall
theoretical foundation for accounting which will guide standard-setters, preparers and users of
financial information in the preparation and presentation of financial statements.
Accounting assumptions are the basic notions or fundamental premises on which the accounting
process is based. These serve as the foundation of accounting in order to avoid
misunderstanding.
There are five basic accounting assumptions, namely Accounting Entity, Going Concern, Time-
Period, Accrual and Monetary Unit.
Accounting Entity Concept
In accounting, the accounting entity is the specific business enterprise which may be sole
proprietorship, a partnership or a corporation. Under this assumption, the business enterprise is
treated as a unit separate and distinct from the owner or owners.
Thus, the personal transactions of the owners not affecting the business are not recorded in the
books of the business. The reason for this concept is to have a fair presentation of financial
statements. This is accomplished by a separate accounting of business transactions from personal
transactions of the owners.
Going Concern
Under this assumption, the business entity will continue to operate indefinitely in the future
unless there is evidence to the contrary.
Long-lived assets are recorded at cost and not expensed outright due to the assumption that this
will still be used in the future.
The going concerned assumption, however, will be abandoned if liquidation of the business
appears to be eminent. In this case, the business is said to be a liquidation concern.
Time-Period
Users of financial information need to make economic decisions t many points during the life of
a business enterprise. Because of this, it becomes necessary to prepare periodic financial reports.
The time-period assumption requires that the indefinite life (under the going concern
assumption) of the business entity be divided into time-periods.
The time periods may be monthly, quarterly, semi-annually or annually.
Accrual
In order to meet the objectives of proper reporting, financial statements should be prepared on
accrual basis of accounting. Accrual accounting means that income is recognized when earned
regardless when received; expense is recognized when incurred regardless of when payment is
made.
The accrual basis of accounting is the main reason why adjustments have to be prepared at the
end of every accounting period. Under this basis, the effects of transactions and other events are
recognized when they occur (and not as cash or its equivalent is received or paid) and they are
recorded in the accounting records and reported in the financial statements in the periods to
which they relate.
Financial statements prepared on the accrual basis inform users not only of past transactions
involving the payment and receipt of cash but also of obligations to pay in the future and of
resources that represent cash to be received in the future. Hence, they provide the type of
information about past transactions and other events that is most useful to users in making
economic decision.
Monetary Unit
Under the monetary unit assumption, only transactions and events that can be quantified in terms
of money are to be recorded in the accounting records.
Transactions that cannot be quantified are ignored for recording purposes.

ACCOUNTING PRINCIPLES
In the observance of the different accounting assumptions, some specific principles should be
followed.
Cost Principle
In accordance with the going concern assumption, assets required should be recorded at cost.
In a cash transaction, cost is equivalent to the cash payment. Thus, if a machine is acquired for
P150,000 cash, the cost of the machine is P150,000. In a non-cash transaction, the cost of an item
acquired is equal to the fair market value of the item acquired whichever is clearly determinable.
Matching Principle
The matching principle required that all cost and expenses incurred in earning revenue should be
reported in the same period the revenue was reported. In other words, when revenue is reported,
all cost and expenses incurred to earn that revenue should also be reported in that same period.
This principle is observed in accrual basis accounting.
Revenue Recognition Principle
Revenue should be recognized when earned. There are two conditions which must be present for
the recognition of revenue:
1. It is probably that future economic benefits will flow to the enterprise.
2. The economic benefits can be measured reliably,
Under the two conditions given, we can conclude that the point of sale is the point of revenue
recognition. The reason is that it is at the point of sale that the enterprise has transferred to the
byer the significant risks and rewards of ownership of the goods. There are, however, some
exceptions (which are to be discussed in your higher accounting courses).

MAJOR FIELDS OF ACCOUNTING

Certified Public Accountants practice their profession in four main areas, namely:
A. Practice of Public Accountancy – A public accountant usually offers three kinds of
services namely auditing, taxation and management advisory services.
B. Practice in Commerce an Industry – A certified public accountant may be engaged in
private industries in different fields such as financial accounting, internal auditing, tax
accounting, cost accounting and budgeting.
 C. Practice in Academe – A certified public accountant’s work involves teaching of
accounting, auditing, management advisory services, finance, taxation, and other
technically related subjects leading to the degree of accountancy. Provided also, that
members of Integrated Bar of the Philippines may be allowed to teach business law and
taxation subjects.

D. Practice in Government – A certified public accountant shall be considered in the practice

of accountancy in government if he holds or is appointed to a position in the accounting
professional group in the government or in the government owned and controlled
corporations, including those performing proprietary functions, and the nature and
character of his employment involves decision making requiring professional knowledge
in the science of accounting and such an employment or position requires that the civil
service eligibility of holders thereof must be Certified Public Accountants.

THE OBJECTIVES OF FINANCIAL STATEMENTS:

The Financial Statements

The financial statements are the means by which the information accumulated and
processed in financial accounting are periodically communicated to the users. The objective of
financial statements is to provide information about the financial position, performance and cash
flows of the enterprise that is vital in making a sound economic decision. There are five (5) basic
financial statements, namely:

1. Statement of Profit or Loss also known as Income Statement- shows the performance
of the enterprise for a given period of time. This statement presents the result of operation
of an enterprise, which would either be a net income, net loss or a break-even.

2. Statement of Changes in Equity- summarizes the changes in equity for a given

period of time. The beginning equity of the owner is increased by the additional
investment and net income. Correspondingly, it is decreased by withdrawal and net loss.

3. Statement of Changes in Financial Position also known as the Balance Sheet- shows
the financial position of an enterprise as of particular date. It shows the assets, liabilities
& owner’s equity thru which the enterprise’s liquidity, solvency, financial structure and
capacity for adaptation could be measured and evaluated.

4. Statement of Cash Flows- provides information about cash inflows (receipts) and
cash outflows (payments) of an entity for a given period of time which are being classified
into a) operating activities b) investing activities; and c) financing activities.

5. Accounting Policies and Notes to Financial Statements- is an “additional” statement

and considered also as basic statement. This presents significant accounting policies that
 affected the financial statements and other disclosures necessary to make the financial
statements more useful.

MAJOR USERS AND USES OF FINANCIAL STATEMENTS

Users of financial information may be broadly categorized into internal or primary users and
external or secondary users.
Internal Users
1. Management – is responsible for ensuring that a company meets its goals. The
management of enterprise has the primary responsibility for the preparation and
presentation of the financial statements of the enterprise.
Management needs financial information for analyzing the organization’s performance
and position and taking appropriate measures to improve the company results.
2. Owners – need financial information for analyzing the viability and profitability of their
investment and determining any future course of action.
3. Employees – need financial information for assessing company’s profitability and its
consequence on their future remuneration and job security.
Accounting information is presented to internal users usually in the form of management
accounts, budgets, forecasts and financial statements.
External Users
1. Creditors – are interested in financial information for determining the credit worthiness of
the organization. Terms of credit are set by creditors according to the assessment of their
customer’s financial health. Creditors include suppliers as well as lenders of finance such
as banks.
2. Investors – the providers of risk capital and their advisers are concerned with the risk
inherent in and return provided by their investments.
3. Customers – have an interest on the information about the continuance of an enterprise
especially when they have long-term involvement with or are dependent on the enterprise.
4. Government and other regulatory authorities – for determining the credibility of the tax
returns filed on behalf of the company and for ensuring that the company’s disclosure of
accounting information is in accordance with the rules and regulations set in order to
protect the interests of the stakeholders who rely on such information in forming their
decisions.
5. Public – Enterprises affect members of the public in a variety of ways. For example,
enterprises may make a substantial contribution to the local economy in many ways
including the number of people they employ and their patronage of local suppliers.
Financial statements may assist the public by providing information about the trends and
recent developments in the prosperity of the enterprise and the range of its activities.

FINANCIAL ACCOUNTING AND MANAGERIAL ACCOUNTING

 As an information system, accounting is usually divided into financial accounting and managerial
accounting. Both financial accounting and managerial accounting exist to provide information,
primarily quantitative, in order to assist decision makers to make informed judgements. The
difference lies on the decision makers or the audience that they serve.

Financial accounting is primarily concerned with generating general-purpose reports that serve
parties outside the firm such as investors, creditors, government agencies, and other outside users.
Being general purpose, this means that data are more aggregated and pertains mostly to the
company as a whole. Report preparations are also well defined and restricted by standards.

Managerial accounting on the other hand, produces information for internal users such as
managers and workers. Reports are prepared specifically for a particular user for a particular
decision. Therefore, the focus is on segments rather than the company as a whole.

THE ACCOUNTING ENVIRONMENT

The subject matter of accounting is economic activity. Economic activities are undertaken by economic
entities. These economic entities are either profit oriented or non-profit oriented.
Profit Oriented Enterprises – are organized for the purpose of earning profit. These entities are called
business enterprises. Business enterprises are individuals or organizations that control and use resources
mainly to earn profit for the owner or owners.
Non-Profit Oriented Entities – are organized not for the purpose of earning profit but for other
purposes. (This topic is discussed in another accounting subject).

BOOKKEEPING AND ACCOUNTING DIFFERENTIATED

Bookkeeping and accounting are two related processes. Bookkeeping is an accounting support
function that involves the systematic and chronological recording of business transaction in
financial terms. Accounting functions at a higher level than bookkeeping does. Accountants
design the accounting information system that the bookkeeper will use to record business
transactions. Accountants may also supervise the work of bookkeepers and prepare financial
statements and tax returns. The bookkeeper’s work is routine when compared to the
accountant’s.
Basically, a bookkeeper does the recording process while the accountant transforms accounting
data into reports (financial statements). Accountants also analyze as well as interpret the reports.
Usually, accountant provides the owner with a guide and a basis for formulating and adopting
financial plans and policies that will lead to efficient management, thereby business goals and
objectives are attained.
REVIEW QUESTIONS:
1. Give at least two definitions of accounting.
2. Give the four functions of accounting and explain each.
3. Explain the accrual basis of accounting.
4. Enumerate and explain the four fields where CPA’s can practice their profession.
5. What are generally accepted accounting principles?
6. Trace the development of accountancy in the Philippines.
7. What are the qualitative characteristics of information in the financial statements?
8. Who are the internal users of financial information and what are their needs?
9. Who are the external users of financial information and what are their needs?
10. What are the elements of faithful representation? Explain.
11. Explain what is conservatism or prudence.
12. What is the difference between financial accounting and managerial accounting?
13. Explain the accounting entity concept.
14. What are the principal components of the accounting process?
15. What are the forms of business organizations according to ownership? Explain each.
16. What is the function of the Financial Reporting Standards Council (FRSC)?
17. Explain the matching principle.
18. What is materiality? Explain
19. Why is accounting often referred to as the language of business?
20. What are the forms of business organizations according to activity? Explain each
I. Matching Type. From the list of possible answers, choose the letter corresponding to the description or
explanation on statements 1 to 20.
_____1. Interested in information that enable them to assess their security of employment and satisfactory
compensation.
_____2. Means categorizing similar items into the same group or same name based on certain
characteristics or bases.
_____3. Inco me is recognized when earned regardless of when received and expense is recognized when
incurred regardless of when paid.
_____4. In the absence of an evidence to the contrary, the enterprise is viewed as continuing in operation
indefinitely.
_____5. Financial information must be comprehensive or intelligible if it is to be useful.
_____6. Financial information should be related or pertinent to the economic decision for which it is to
be used.
_____7. Needs financial information for analyzing the organization’s performance and position and
taking appropriate measures to improve the company’s results.
_____8. All significant information leading to the preparation of financial statements should be included.
_____9. This attitude is often expressed in the statement “Anticipate no profits and provide for all
probable losses that can be reasonably estimated”.
_____10. An artificial being created by the operation of law, having the right of succession, and the
powers, attributes and properties expressly authorized by law or incident to its existence.
_____11. The economic substance of transactions and events are usually emphasized when it differs
from legal form.
_____12. Produces information for internal users such as managers and workers. Reports are prepared
specifically for a particular user for a particular decision.
_____13. Strict adherence to accounting theory is not required when the items are not significant enough
to affect the evaluation, decision, and fairness of the financial statements.
_____14. Accounting information must be available or communicated early enough when a decision is to
be made.
_____15. The benefits derived from information should exceed the cost of providing it.
_____16. The statement of financial position/balance sheet should represent faithfully the transaction and
other events that results in assets, liabilities and equity of the enterprise at the reporting date.
_____17. The financial information will help them determine whether they should hold or sell their
investments.
_____18. Cash receipts are treated as revenues when received and cash payments as expenses when paid.
_____19. A summary of the terms and concepts that underlie the preparation and presentation of
financial statements.
_____20. The ability to bring them together for the purpose of noting points of likeness and differences.

LIST OF POSSIBLE ANSWERS:

A. Substance over form
B. Corporation
C. Comparability
D. Completeness
E. Materiality
F. Understandability
G. Cost-benefit Analysis
H. Faithful Representation
I. Understandability
J. Classifying
K. Conservatism
L. Managerial accounting
M. Employees
N. Conceptual Framework
O. Cash Basis
P. Investors
Q. Management
R. Relevance
S. Going Concern
T. Accrual Basis
II. Multiple Choice. Encircle the letter of your choice.
1. The principle that requires all relevant information that would affect the user’s understanding and
assessment of the accounting entity be disclosed in the financial statements.
a. Objectivity principle
b. Full disclosure
c. Revenue recognition principle
d. Materiality principle

2. Which statement is false?

a. The communication component of accounting process includes recording, classifying and
summarizing.
b. Accounting identifies, measures, and communicates information about economic entities
for use in making economic decisions.
c. Accounting is a service activity.
d. None of these
3. It is the accumulation and communication of information for use by internal parties
a. Financial accounting
b. Auditing
c. Managerial accounting
d. Tax accounting

4. Assets should be recorded initially at original acquisition cost.

a. Objectivity
b. Cost principle
c. Time-period assumption
d. Materiality

5. Accounting procedures or methods should be applied on a uniform basis from period to period
a. Materiality
b. Comparability
c. Consistency
d. Objectivity

6. The business should be treated as separate and distinct form the owner or owners. Transactions
not affecting the business should not be recorded in the books of the business.
a. Personality concept
b. Entity concept
c. Periodicity concept
d. Stable monetary unit
7. A conceptual framework is
a. A statement of financial accounting standards
b. An underlying accounting assumption
c. A theoretical foundation which guides the ASC/FRSC, preparers and users of financial
accounting information
d. A financial statement

8. The person who reviews the operating and accounting control procedures adopted by
management to make sure the controls are adequate may be referred to as a(an)
a. Bookkeeper
b. Accountant
c. Information processor
d. Internal auditor

9. All of the following describe accounting, except

a. A service activity
b. An information system
c. A universal language of business
d. An exact science rather than art

10. The important point made in the definition of accounting include all of the following, except
a. Accounting information is quantitative
b. Accounting information is both quantitative and qualitative
c. Accounting information is financial in nature
d. Accounting information is useful in decision making

11. This accounting process is the recognition or non-recognition of activities as accountable events
a. Measuring
b. Identifying
c. Communicating
d. Reporting

12. The “measuring” component of accounting is

a. The recognition or non-recognition of business activities as accountable events.
b. The assigning of peso amounts to accountable events
c. The preparation and distribution of accounting reports to potential users of accounting
information
d. The preparation of audit reports by CPAs

13. The most common financial attribute used in measuring financial information is
a. Cost or historical cost
b. Current cost
c. Realizable value
d. Present value

14. It is the accounting standard setting body in the Philippines at the present time
a. Accounting Standards Council
 b. Auditing and Assurance Standards Council
c. Philippine Accounting Standards Board
d. Financial Reporting Standards Council

15. The IASB publishes standards called

a. International Accounting Standards
b. Financial Reporting Standards
c. International Financial Reporting Standards
d. Statement of Financial Accounting Standards