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uACCOUNTING AND THE BUSINESS ENVIRONMENT

uUniversity of the Philippines VISAYAS TACLOBAN COLLEGE

uDivision of management

uBA 99.1 Fundamentals of Accounting Theory and Practice I

uLEARNING OBJECTIVES:

1.Understand the nature of business and the role of accounting in business.

2.Differentiate the branches of accounting.

3.Describe the users of accounting information and why accounting information is important to them.

4.Classify the forms of business organization and the nature of business.

uLEARNING OBJECTIVES:

5.Describe the generally accepted accounting principles.

6.Discuss the framework for the preparation of financial statement.

7.Describe the accounting equation.

8.Classify the elements of the financial statements and their sub-elements.

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uLEARNING OBJECTIVES:

9.Illustrate a chart of accounts.

10.Use the accounting equation to analyze business transactions.

11.Illustrate the interrelationship of the basic financial statements.

uORGANIZATION

uAn organization is a social entity that is structured to accomplish an overall, common goal or set of goals.

uORGANIZATION

uAn organization utilizes resources to attain its objectives.

uResources, however, are limited.

uACCOUNTING

uAccounting is said to be the language of business.

uIt is an information system.

uIt is a way to convey information about a business to users.

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uACCOUNTING

uThe earliest form of accounting can be traced back to ancient Mesopotamia.

uIts early development is closely related to developments in writing, counting, and money.

uLuco Pacioli, known as the father of accounting, first described the system of double-entry bookkeeping used by Venetian merchants.

uACCOUNTING

uThe industrial revolution has necessitated the need for more advanced accounting systems, and accounting has evolved to what it is today.

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uACCOUNTING

uIt 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 Institute of Certified Public Accountants

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uACCOUNTING

uThe objective of accounting is to provide relevant, timely information used in making decisions about how to allocate scarce resources.

uAlthough accountants place much emphasis on reporting what has already occurred, this past information is intended to be useful in making economic decisions about the future.

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uTHE ACCOUNTING PROCESS

uTHE ACCOUNTING PROCESS

uPRACTICE AREAS OF ACCOUNTING

uAccounting, being a diverse field, has the following general practice areas:

1.Financial Accounting

uThis area of accounting deals with the recording of business transactions leading to the preparation of general-purpose financial statements.

uIt does not pertain to a specific user group.

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uPRACTICE AREAS OF ACCOUNTING

2.Management Accounting

uThe provision of accounting information for use by managers in planning and controlling operations.

uReports are not publicly available. They are for internal uses only.

uDoes not follow any general financial reporting framework. It is largely dependent on the information needs of internal users.

uPRACTICE AREAS OF ACCOUNTING

FINANCIAL vs. MANAMENT ACCOUNTING

uPRACTICE AREAS OF ACCOUNTING

3.Government Accounting

uThe practice of accounting within the coffers of government.

uAny CPA who holds or is appointed to a position in government or any GOCC whose civil service eligibility requires that the holder of the position be a Certified Public Accountant. (RA 1080 eligibility)

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uPRACTICE AREAS OF ACCOUNTING

4.Auditing

uThe work of an auditor starts when the work of an accountant ends.

uAuditing is the independent verification of financial transactions and accounting reports to check their fairness and reliability.

uAfter financial reports are prepared, they have to be examined to ensure that they do not present a distorted picture to the general public.

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uPRACTICE AREAS OF ACCOUNTING

5.Tax Accounting

uIt is a specialized field in accounting that involves the preparation of tax returns for the BIR.

uThis also includes tax planning to ensure the proper payment of taxes, while at the same time trying to minimize the amount of taxes paid.

uPRACTICE AREAS OF ACCOUNTING

6.Cost Accounting

uThis involves the accumulation of the costs of inputs as well as other production costs for manufacturing entities in order to ensure the proper reporting of amounts in the financial statements.

uRelates to product costing.

uPRACTICE AREAS OF ACCOUNTING

7.Academe/Education

uThis involves CPAs in educational institutions involved in the teaching of accounting, auditing, management advisory services, finance, business law, taxation, and other technically-related subjects.

uIn HEIs (tertiary), this practice area is regulated by the PRC – Board of Accountancy.

uPRACTICE AREAS OF ACCOUNTING

8.Accounting Research

uThis may either refer to practitioners or academicians.

uAccounting practitioners take the form of consultants who are tasked to research on the effects of economic events and its impacts to the company.

uAcademicians, on the other hand, research on all aspects affecting the profession.

uDecision Makers: The Users of Accounting Information

Stakeholders

uParties who have an interest in an entity, whether direct or indirect.

uThey are generally the users of financial information.

uThey can be classified as either internal or external.

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uDecision Makers: The Users of Accounting Information

uUSERS AND THEIR INFORMATION NEEDS

uFORMS OF BUSINESS ORGANIZATIONS

1.Sole Proprietorship

uA business that is owned by a single individual who is usually the manager.

uFor legal purposes and for tax purposes, the business and the owner are considered the same.

uThe owner absorbs all profits and losses of the business.

uFORMS OF BUSINESS ORGANIZATIONS

1.Sole Proprietorship

uThe business owner is personally responsible or liable for all of the debts and obligations of the business.

uThis is the form of business organization common to small enterprises.

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uFORMS OF BUSINESS ORGANIZATIONS

2.Partnership

uA business owned and operated by two or more natural persons who bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing profits among themselves.

uThe acts of the partners (owners) bind the partnership (business).

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uFORMS OF BUSINESS ORGANIZATIONS

3.Corporation

uA corporation is a separate legal entity created by operation of law.

uThis business is owned by many individuals referred to as stockholders/shareholders.

uOwnership is in the form of shares of stocks.

uThis is the most complex form of business organization.

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uFORMS OF BUSINESS ORGANIZATIONS

4.Cooperatives

uA cooperative is a duly registered association of persons, with a common bond of interest, who have voluntarily joined together to achieve their social, economic, and cultural needs and aspirations by making equitable contribution to the capital required, patronizing their products and services, and accepting a fair share of risks and benefits of the undertaking.

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uFORMS OF BUSINESS ORGANIZATIONS

4.Cooperatives

uCooperatives enjoy incentives that are otherwise not available to other forms of business organizations.

uThey may be formed for the purpose of lending, housing, utilities provision, among others.

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uTYPES OF BUSINESS ACTIVITIES

1.Service

uA service firm sells services to its customers. In other words, it sells time.

uIt may also make its facilities available for a fee.

uCommon types of service businesses include law firms, accounting firms, physical therapy offices, painting companies, and automotive repair shops.

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uTYPES OF BUSINESS ACTIVITIES

2.Merchandising

uA merchandising or trading business sells physical goods or products to its customers.

uA merchandise business may be either a wholesale business or a retail business.

uA wholesale business is a business that sells products to other businesses for resale.

uTYPES OF BUSINESS ACTIVITIES

2.Merchandising

uA retail business is a business that sells products to the final consumer of the product.

uCommon types of merchandise businesses include grocery stores, automobile dealers, and department stores.

uTYPES OF BUSINESS ACTIVITIES

3.Manufacturing

uA manufacturing business produces the physical goods that it sells to its customers.

uThe common types of manufacturing businesses include food manufacturers, the makers of clothing, and soft drink manufacturers.

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uACCOUNTING CONCEPTS AND PRINCIPLES

uThe Philippines generally follows International Financial Reporting Standards (IFRS).

uThe current accounting standard-setting body in the Philippines is the Financial Reporting Standards Council (FRSC).

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uACCOUNTING CONCEPTS AND PRINCIPLES

uFUNDAMENTAL CONCEPTS IN ACCOUNTING

Entity Concept

uThe business enterprise is separate from owners, managers, and employees who form part of the firm.

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uFUNDAMENTAL CONCEPTS IN ACCOUNTING

Periodic Reporting

uMeaningful financial information about an entity can be provided for periods of time that are shorter than the life of an entity.

uUsually equal time periods for purposes of comparability.

uThe most common reporting period is annual.

uCalendar Year vs. Fiscal Year

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uFUNDAMENTAL CONCEPTS IN ACCOUNTING

Unit of Measure

uIn order for accounting to present useful information, it must be able to express information in a common unit of measure.

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uBASIC PRINCIPLES IN ACCOUNTING

Objectivity Principle

uAccounting records are based on the most reliable data available for them to be as useful as possible.

uReliable data are those that can be verified.

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uBASIC PRINCIPLES IN ACCOUNTING

Historical Cost Principle

uAcquired assets should be recorded at their actual ACQUISITION COST and not at what management thinks they are worth at reporting date.

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uBASIC PRINCIPLES IN ACCOUNTING

Accrual

uThe effects of transactions are recorded as they occur and not as cash is received or paid and they are recorded in the period which they relate to.

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uRECOGNITION PRINCIPLE

uTo recognize is to incorporate in the financial statements an item that meets the ff. criteria for recognition:

uIt is probable that any future economic benefit associated with the item will flow to/from the enterprise!

uThe item has a cost/value that can be measured with reliability!

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uACCRUAL ACCOUNTING

uBASIC PRINCIPLES IN ACCOUNTING

Adequate Disclosure

uAll relevant information that would affect user’s understanding of financial information should be disclosed in the financial statements.

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uBASIC PRINCIPLES IN ACCOUNTING

Materiality

uMateriality is an entity-specific aspect of relevance.

uFinancial reporting is only concerned with information that is significant enough to affect decisions.

uMateriality is dependent on the size or nature of the transaction involved.

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uBASIC PRINCIPLES IN ACCOUNTING

Materiality

uA ₱100 bribe is MATERIAL while a ₱100 error in the recording of a building which costs ₱10 million is not.

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uBASIC PRINCIPLES IN ACCOUNTING

Consistency Principle

uAccounting methods should not change from period to period so as to ensure uniformity and comparability.

uChanges are justifiable as long as they are disclosed in the financial statements.

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uFUNDAMENTAL QUALITATIVE CHARACTERISTICS

uUnder the latest version (2010) of the IFRS Conceptual Framework for Financial reporting, the fundamental qualitative characteristics are:

uRelevance

uFaithful Representation

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uFUNDAMENTAL QUALITATIVE CHARACTERISTICS

Relevance

uRelevant financial information is capable of making a difference in decisions made by users.

uThe principal ingredients or relevance are the predictive and confirmatory roles of information.

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uFUNDAMENTAL QUALITATIVE CHARACTERISTICS

Relevance

uPredictive Role – information is used as an input to predict future outcomes.

uConfirmatory Role – information can confirm or correct earlier expectations.

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uFUNDAMENTAL QUALITATIVE CHARACTERISTICS

Faithful Representation

uFinancial information must represent faithfully what it purports to represent.

uIn determining faithful representation, we consider information’s completeness, neutrality, and freedom from error.

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uFUNDAMENTAL QUALITATIVE CHARACTERISTICS

Faithful Representation

uCompleteness – information presented must be complete.

uNeutrality – free from any biases.

uFreedom from error – no errors or omissions in the performance of processes used to record financial information. This does not mean that financial information is perfect.

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uENHANCING QUALITATIVE CHARACTERISTICS

uUnder the latest version (2010) of the IFRS Conceptual Framework for Financial reporting, the enhancing qualitative characteristics are:

uComparability

uVerifiability

uTimeliness

uUnderstandability

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uENHANCING QUALITATIVE CHARACTERISTICS

Comparability

uInformation is more useful if it can be compared with information about other entities and with similar information within the same entity covering another period.

uENHANCING QUALITATIVE CHARACTERISTICS

Verifiability

uThis ensures that information represent faithfully the economic phenomena it purports to represent.

uVerifiability means that different knowledgeable and independent observers could reach consensus (not necessarily complete agreement) that a particular depiction is faithful representation.

uENHANCING QUALITATIVE CHARACTERISTICS

Timeliness

uInformation must be available to decision-makers in time to be capable of influencing their decisions.

uUNDERLYING ASSUMPTION IN ACCOUNTING

Going Concern

uIn the absence of any proof to the contrary, an entity will continue its normal operations in the foreseeable future.

uACCOUNTING EQUATION

uThe accounting equation is the basic tool of accounting, measuring the resources of the business and the claims to those resources.

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uACCOUNTING EQUATION

uACCOUNTING EQUATION

uACCOUNTING EQUATION

uASSETS

uAssets are resources controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.

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uASSETS

“controlled by the enterprise”

Control is the ability to obtain the economic benefits and to restrict others from access.

(ex. Your pen which you may or may not lend to your seatmate!)

uASSETS

“result of past events”

An event must have happened already before an asset can arise!

(ex. A pen at NBS is not your asset unless you have already purchased it!)

uASSETS

“future economic benefits”

In a business, this is the prospective receipt of cash flow!

(ex. Motorcycle = to deliver pizzas = sale of pizza = cash receipt)

uLIABILITIES

uLiabilities are present obligations arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

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uLIABILITIES

“obligations”

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May be legal or not.

Something the enterprise owes to others!

uOWNER’S EQUITY

uThe money provided to the business through an initial investment by the owners or the retention of profits by the business.

uThis is the residual interest of owners in the assets of the business after deducting all of its liabilities.

uMade up of the owner’s investment, withdrawal, and net income or net loss for the period.

uOWNER’S EQUITY

Investments

uThese are the assets put into the business by its owner.

uIncreases owner’s equity.

Withdrawal

uThese are the assets removed from the business by the owner.

uDecreases owner’s equity.

uOWNER’S EQUITY

uINCOME

uIncome is an increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants (owners).

uINCOME

uAn income item may either be a revenue or a gain.

uRevenues are income earned (by performing services or selling goods) by the company in the usual course of business.

uGains are income earned from peripheral activities outside the usual course of business.

uRevenues and gains increase owner’s equity.

uEXPENSES

uExpenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants (owners).

uEXPENSES

uExpenses are the costs that the company incurs in carrying on operations in its effort to earn revenue.

uExpenses decrease owner’s equity.

uACCOUNT

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uThe accounting equation contains three parts: assets, liabilities, and equity. Each part contains accounts.

uAn account is the detailed record of all increases and decreases that have occurred in an account during a specific period.

uASSETS

uLIABILITIES

uOWNER’S EQUITY

uCHART OF ACCOUNTS

uA chart of accounts is used to organize a company’s accounts.

uA company decides on its own chart of accounts.

uCHART OF ACCOUNTS

uBUSINESS TRANSACTIONS

uA transaction warranting recording is any event that affects the financial position of the business and can be measured with faithful representation.

uOPERATING THE BUSINESS

uTo help better understand the accounting equation, let us look into how a business operates.

uTo operate, businesses need to acquire money or resources and use them to make a profit.

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uOPERATING THE BUSINESS

A firm acquires money (an asset) by:

uBorrowing money from lenders or creditors (called liabilities).

uGetting owners to put in their money (called owners’ equity) in exchange for a percentage of ownership.

uOPERATING THE BUSINESS

uTRANSACTION ANALYSIS

uTransactions can be analyzed in 3 steps:

Step 1: Identify the account and account type.

Step 2: Decide if each account increases or decreases.

Step 3: Determine if the accounting equation is in balance.

uTRANSACTION ANALYSIS

Transaction 1—Owner Contribution

uSheena Bright contributes $30,000 cash to start a new business as a sole proprietorship named Smart Touch Learning on November 1,2016. The effect of this transaction on the accounting equation is:

uTRANSACTION ANALYSIS

Transaction 2—Purchase of Land for Cash

uSmart Touch Learning purchases land for an office location, paying cash of $20,000.

uTRANSACTION ANALYSIS

Transaction 3—Purchase of Office Supplies on Account

uSmart Touch Learning buys office supplies on account, which is a liability called Accounts Payable, agreeing to pay $500 within 30 days.

uTRANSACTION ANALYSIS

Transaction 4—Earning of Service Revenue for Cash

uSmart Touch Learning earns service revenue by providing training services for clients. The business earns $5,500 of revenue and collects this amount in cash.

uTRANSACTION ANALYSIS

Transaction 5—Earning of Service Revenue on Account

uSmart Touch Learning performs a service for clients who do not pay immediately. The clients promise to pay $3,000 within one month. This promise is an asset called accounts receivable.

uTRANSACTION ANALYSIS

Transaction 6—Payment of Expenses with Cash

uSmart Touch Learning pays $3,200 in cash expenses: $2,000 for office rent and $1,200 for employee salaries.

uTRANSACTION ANALYSIS

Transaction 7—Payment on Account (Accounts Payable)

uSmart Touch Learning pays $300 to the store from which it purchased office supplies in Transaction 3.

uTRANSACTION ANALYSIS

Transaction 8—Collection on Account (Accounts Receivable)

uSmart Touch Learning now collects $2,000 from the client from Transaction 5.

uTRANSACTION ANALYSIS

Transaction 9—Owner Withdrawal of Cash

uSheena Bright withdraws $5,000 cash from the business.

uTRANSACTION ANALYSIS

uFINANCIAL STATEMENTS

uHow will people use the information provided in the example presented?

uTo address this important question, we need financial statements.

uFinancial statements are business documents that are used to communicate information needed to make business decisions.

uFINANCIAL STATEMENTS

uThere are four basic financial statements, namely the income statement, balance sheet, statement of changes in equity, and the statement of cash flows.

uFor the purpose of this short course, we will only focus on the income statement, the statement of changes in equitu, and the balance sheet.

uFINANCIAL STATEMENTS

uINCOME STATEMENT

uThe income statement reports the net income (profit) or net loss of the business for a specific period.

uThe net income is arrived at by subtracting expenses from revenues.

uINCOME STATEMENT

uIf Revenues = Expenses, there is neither a profit nor a loss. (BREAKEVEN)

uIf Revenues > Expenses, there is a net income/profit. This increases owner’s equity.

uIf Expenses > Revenues, there is a net loss. This decreases owner’s equity.

uINCOME STATEMENT

uSTATEMENT OF CHANGES IN EQUITY

uThe statement of changes equity shows the changes in capital for a business entity during a time period, such as a month, quarter, or year.

uThe net income must first be calculated on the income statement and then carried to the statement of owner’s equity.

uThis also includes investments or withdrawals by owners.

uSTATEMENT OF CHANGES IN EQUITY

uBALANCE SHEET

uThe balance sheet (also called the statement of financial position) lists a business entity’s assets, liabilities, and owner’s equity as of a specific date, usually the end of a month, quarter, or year.

uThe balance sheet is a snapshot of the entity.

uAn investor or creditor can quickly assess the overall health of a business by viewing the balance sheet

uBALANCE SHEET

uFINANCIAL STATEMENTS PREPARATION

uThe income statement is prepared first.

uNet income or loss is needed for the statement of owner’s equity.

uThe statement of owner’s equity is prepared second.

uThe net income or net loss comes from the income statement.

uThe balance sheet is prepared last.

uThe balance in Capital comes from the statement of owner’s equity.

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THE END

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