Chapter 1: Introduction to Accounting
Definition of accounting
Accounting is a process of identifying, recording and communicating economic
information that is useful in making economic decisions.
Essential elements of the definition of accounting
1. Identifying – The accountant analyzes each business transaction and identifies
whether the transaction is an “accountable event” or “non-accountable event.”
This is because only “accountable events” are recorded in the books of
accounts. “Non-accountable events” are not recorded in the books of accounts.
2. Recording – The accountant recognizes (i.e., records) the “accountable events”
he has identified. This process is called “journalizing.” After journalizing, the
accountant then classifies the effects of the event on the “accounts.” This
process is called “posting.”
3. Communicating – At the end of each accounting period, the accountant
summarizes the information processed in the accounting system in order to
produce meaningful reports. Accounting information is communicated to
interested users through accounting reports, the most common form of which is
the financial statements.
Nature of accounting
Accounting is a process with the basic purpose of providing information about
economic activities intended to be useful in making economic decisions.
Types of information provided by accounting
1. Quantitative information
2. Qualitative information
3. Financial information
Functions of Accounting in Business
1. To provide external users with information that is useful in making investment and
credit decisions; and
2. To provide internal users with information that is useful in managing the business.
Brief history of accounting
• Accounting can be traced as far back as the prehistoric times, perhaps more than
10,000 years ago.
• Archaeologists have found clay tokens as old as 8500 B.C. in Mesopotamia
which were usually cones, disks, spheres and pellets. These tokens correspond
to commodities like sheep, clothing or bread. They were used in the Middle West
in keeping records. After some time, the tokens were replaced by wet clay
tablets. During such time, experts concluded this to be the start of the art of
writing. (Source: http://EzineArticles.com/456988)
• Double entry records first came out during 1340 A.D. in Genoa.
• In 1494, the first systematic record keeping dealing with the “double entry
recording system” was formulated by Fra Luca Pacioli, a Franciscan monk and
mathematician. The “double entry recording system” was included in Pacioli’s
book titled “Summa di Arithmetica Geometria Proportioni and Proportionista,”
published on November 10, 1494 in Venice.
• The concept of “double entry recording” is being used to this day. Thus, Fra Luca
Pacioli is considered as the father of modern accounting.
Common Branches of Accounting
Users of Accounting Information
1. Internal users – those who are directly involved in managing the business.
Examples:
• Business owners who are directly involved in managing the business
• Board of directors
• Managerial personnel
2. External users – those who are not directly involved in managing the business.
Examples:
• Existing and potential investors (e.g., stockholders who are not directly
involved in managing the business)
• Lenders (e.g., banks) and Creditors (e.g., suppliers)
• Non-managerial employees
• Public
Forms of Business Organizations
Advantages and Disadvantages
Types of Business According to Activities
1. Service business
2. Merchandising (Trading)
3. Manufacturing
Chapter 2: Accounting Concepts and Principles
Basic Accounting Concepts
1. Separate entity concept 7. Time Period
2. Historical cost concept 8. Stable monetary unit
3. Going concern assumption 9. Materiality concept
4. Matching 10. Cost-benefit
5. Accrual Basis 11. Full disclosure principle
6. Prudence (or Conservatism) 12. Consistency concept
• Separate entity concept – The business is viewed as a separate entity, distinct
from its owner(s). Only the transactions of the business are recorded in the
books of accounts. The personal transactions of the business owner(s) are not
recorded.
• Historical cost concept (Cost principle) – assets are initially recorded at their
acquisition cost.
• Going concern assumption – The business is assumed to continue to exist for
an indefinite period of time.
• Matching – Some costs are initially recognized as assets and charged as
expenses only when the related revenue is recognized.
• Accrual Basis of accounting – income is recorded in the period when it is
earned rather than when it is collected, while expense is recorded in the period
when it is incurred rather than when it is paid.
• Prudence – The observance of some degree of caution when exercising
judgments under conditions of uncertainty. Such that, if there is a choice between
a potentially unfavorable outcome and a potentially favorable outcome, the
unfavorable one is chosen. This is necessary so that assets or income are not
overstated and liabilities or expenses are not understated.
• Reporting Period – The life of the business is divided into series of reporting
periods.
• Stable monetary unit – Assets, liabilities, equity, income and expenses are
stated in terms of a common unit of measure, which is the peso in the
Philippines. Moreover, the purchasing power of the peso is regarded as stable.
Therefore, changes in the purchasing power of the peso due to inflation are
ignored.
• Materiality concept – An item is considered material if its omission or
misstatement could influence economic decisions. Materiality is a matter of
professional judgment and is based on the size and nature of an item being
judged.
• Cost-benefit – The costs of processing and communicating information should
not exceed the benefits to be derived from the information’s use.
• Full disclosure principle – Information communicated to users reflect a balance
between detail and conciseness, keeping in mind the cost-benefit principle.
• Consistency concept – Like transactions are accounted for in like manner from
period to period.
Philippine Financial Reporting Standards (PFRSs)
The PFRSs are Standards and Interpretations adopted by the FRSC. They consist of
the following:
1. Philippine Financial Reporting Standards (PFRSs);
2. Philippine Accounting Standards (PASs); and
3. Interpretations
4.
Qualitative Characteristics
I. Fundamental Qualitative Characteristics
i. Relevance (Predictive Value, Confirmatory Value, Materiality)
ii. Faithful Representation (Completeness, Neutrality,
Free from error)
II. Enhancing Qualitative Characteristics
i. Comparability
ii. Verifiability
iii. Timeliness
iv. Understandability
Fundamental vs. Enhancing
• The fundamental qualitative characteristics are the characteristics that make
information useful to users.
• The enhancing qualitative characteristics are the characteristics that enhance
the usefulness of information
Relevance
• Information is relevant if it can affect the decisions of users.
• Relevant information has the following:
a. Predictive value – the information can be used in making predictions
b. Confirmatory value – the information can be used in confirming past
predictions
c. Materiality – is an ‘entity-specific’ aspect of relevance.
Faithful representation
• Faithful representation means the information provides a true, correct and
complete depiction of what it purports to represent.
• Faithfully represented information has the following:
a. Completeness – all information necessary for users to understand the
phenomenon being depicted is provided.
b. Neutrality – information is selected or presented without bias.
c. Free from error – there are no errors in the description and in the process
by which the information is selected and applied.
Enhancing Qualitative Characteristics
1. Comparability – the information helps users in identifying similarities and
differences between different sets of information.
2. Verifiability – different users could reach consensus as to what the information
purports to represent.
3. Timeliness – the information is available to users in time to be able to influence
their decisions.
4. Understandability – users are expected to have:
a. reasonable knowledge of business activities; and
b. willingness to analyze the information diligently.
