1.

Definition of Accounting

Since you are not Accountancy students, we will start on the basic of the course, the
definition. There are a lot of definitions given to accounting by different bodies and
organizations. Some of these are:

1. From the American Institute of Certified Public Accountants

(AICPA): Accounting is the art of recording, classifying, and 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;
2. From the American Accounting Association (AAA): Accounting is the process of
identifying, measuring and communicating economic information to permit informed
judgment and decision by users of the information.
3. From the Accounting Standards Council (ASC), succeeded by Financial
Reporting Standards Council (FRSC): 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 decision.

There are a lot more definitions given but we will just pay attention to the above
mentioned definitions as they are the most common.
For the first definition, we can derive the “what-we-call” phases of accounting, namely:

1. Recording- refers to the routine process of preparing journal entries for business
transactions and events in a chronological manner in accordance with accounting
rules and standards. This is also known as “journalizing”.
2. Classifying – pertains to the grouping of transactions recorded according to class
(accounts). Example, all transactions involving cash must be grouped together. This
is done by posting the accounts to ledgers.
3. Summarizing - involves the preparation of financial statements, namely: balance
sheet (statement of financial position), income statement (statement of
comprehensive income), statement of changes in equity, statement of cash flows
and notes to the financial statements accompanying these statements.
4. Interpretation– pertains to the use of accounting information or financial statements
of an entity for decision-making.

 
For the second definition, we can derive the following processes:

1. Identifying- pertains to the determination of accountable events (business

transactions)
2. Measuring– involves assignment of amounts or value to the accountable economic
transactions and events.
3. Communicating – refers to the preparation and distribution of accounting reports to
potential users of accounting information.
For the third definition, just remember these key words/phrases:

1. Quantitative information- refers to numbers

2. Financial - refers to money
3. Economic entities- pertains to business
4. Economic decision- pertains to the purpose of accounting.

With this, you can come up with the definition of accounting using your own words just
by taking into consideration these key words. 

M1- Lesson 1: Introduction to

Accounting 2
2. Nature of Accounting

Accounting is considered both an art and a science. As taken from Accountingverse,

Accounting is considered as an art because it requires the use of skills and creative
judgment. One has to be trained in this discipline to be able to perform accounting
functions well.
It is also considered a science because it is a body of knowledge. In fact, it involves a
systematic process of recording business transactions and communicating the financial
statements to potential users.
 

3. Function of Accounting in business

From the illustration presented, it is clear that the ultimate purpose of accounting is to
provide information to different users. The users utilize the information in making
economic decisions.
 
What kind and particular information does accounting provide?
 
As taken from Accountingverse.com, the following are the particular information of an
economic entity that accounting provides to potential users:

1. Results of operations.This pertains to the profit generated by the company for a certain
span of time (for a year, for a quarter, for a month, etc.). This is measured by deducting all
expenses from all income. The resulting amount is called net income.
2. Financial position.How much resources does the entity currently have? How much does
the entity owe third parties? How much is left for the owners after we pay all obligations
using our resources? The first question refers to the entity's total assets; the second
to liabilities, and the third to capital.
3. Solvency and liquidity.Solvency refers to the entity's ability to pay obligations when they
become due. Liquidity pertains to its ability to meet short-term
4. Cash flows.The financial statements also show the inflows and outflows of cash in the
different activities of the business (operating, investing, and financing activities).
5. Other information.The financial statements provide qualitative, quantitative,
and financial One of the characteristics of the financial statements is relevance. Any
information that could affect the decisions of users should be included in the financial
reports.

 
Accounting is considered the “language of business” simply because the financial
reports generated by doing accounting are communicated to interested parties for
decision-making. These financial reports reflect the performance in the previous period
that will serve as the basis for future decision-making. For example, an investor wants
to know the financial performance of a particular company to know if it is worth it to
invest to that company. In business, transactions should be measurable in terms of
money and these transactions are reflected in the financial reports using accounting.
Moreover, accounting is not synonymous with bookkeeping. In the phases of accounting
previously discussed. the bookkeeping starts with the recording phase until
summarizing phase, while accounting includes bookkeeping  and the interpretation
phase. 
Bookkeeping is the procedural element or phase of accounting, which means that it is
the routine activity while accounting, apart from the routine activity, it involves the
application of professional judgement that is needed in interpreting the financial
statements.
When we talk of history of accounting, the name Fr. Luca Pacioli will always be mentioned. He
was considered as the "father" of Accounting primarily because of his published book, "Summa
de Arithmetica, Geometria, Proportionis et Proportionalita."

M1- Lesson 2: Branches of

Accounting
Due to economic, industrial, and technological developments, different specialized fields
in accounting have emerged.
Accountingverse.com enumerates the famous branches or types of accounting as
follows:
1. Financial Accounting
Financial accounting involves recording and classifying business transactions, and
preparing and presenting financial statements to be used by internal and external users.
In the preparation of financial statements, strict compliance with generally accepted
accounting principles or GAAP is observed. Financial accounting is primarily concerned
in processing historical data.
2. Managerial Accounting
Managerial or management accounting focuses on providing information for use
by internal users, the management. This branch deals with the needs of the
management rather than strict compliance with generally accepted accounting
principles.
Managerial accounting involves financial analysis, budgeting and forecasting, cost
analysis, evaluation of business decisions, and similar areas.
3. Cost Accounting
Often times considered as a subset of management accounting, cost accounting refers
to the recording, presentation, and analysis of manufacturing costs. Cost accounting is
very useful in manufacturing businesses since they have the most complicated costing
process.
Cost accountants also analyze actual costs versus budgets or standards to help
determine future courses of action regarding the company's cost management.
4. Auditing
External auditing refers to the examination of financial statements by an independent
party with the purpose of expressing an opinion as to fairness of presentation and
compliance with GAAP. Internal auditing focuses on evaluating the adequacy of a
company's internal control structure by testing segregation of duties, policies and
procedures, degrees of authorization, and other controls implemented by management.
5. Tax Accounting
Tax accounting helps clients follow rules set by tax authorities. It includes tax planning
and preparation of tax returns. It also involves determination of income tax and other
taxes, tax advisory services such as ways to minimize taxes legally, evaluation of the
consequences of tax decisions, and other tax-related matters.
6. Accounting Information Systems
Accounting information systems (AIS) involves the development, installation,
implementation, and monitoring of accounting procedures and systems used in the
accounting process. It includes the employment of business forms, accounting
personnel direction, and software management.
7. Fiduciary Accounting
Fiduciary accounting involves handling of accounts managed by a person entrusted with
the custody and management of property of or for the benefit of another person.
Examples of fiduciary accounting include trust accounting, receivership, and estate
accounting.
8. Forensic Accounting
Forensic accounting involves court and litigation cases, fraud investigation, claims and
dispute resolution, and other areas that involve legal matters. This is one of the popular
trends in accounting today.
 
Other fields of accounting are:

1. Accounting Research

Accounting research involves the examination on how accounting is utilized by

interested parties following the scientific-based approach. Basically, this serves as an
avenue for the continuous improvement of the accountancy profession through research
and studies.

2. Accounting Education

Accounting education is the branch of accounting that is concerned with the retooling of
CPAs and training of future accountants.
M1- Lesson 3: Users of
Accounting Information
As discussed in the first lesson of this module, the purpose of accounting is to help in
business decision-making of potential users. At this point, we shall enumerate, classify,
and identify the specific needs of these potential users.
 
The users of accounting information include: the owners and investors, management,
suppliers, lenders, employees, customers, the government, and the general public.
1. Owners and investors
Stockholders of corporations need financial information to help them make decisions on
what to do with their investments (shares of stock), i.e. hold, sell, or buy more.
Prospective investors need information to assess the company's potential for success
and profitability. In the same way, small business owners need financial information to
determine if the business is profitable and whether to continue, improve or drop it.
2. Management
In small businesses, management may include the owners. In huge organizations,
however, management is usually made up of hired professionals who are entrusted with
the responsibility of operating the business or a part of the business. They act as agents
of the owners.
The managers, whether owners or hired, regularly face economic decisions – How
much supplies will we purchase? Do we have enough cash? How much did we make
last year? Did we meet our targets? All those, and many other questions and business
decisions, require analysis of accounting information.
3. Lenders
Lenders of funds such as banks and other financial institutions are interested in the
company’s ability to pay liabilities upon maturity (solvency).

 4. Trade creditors or suppliers

Like lenders, trade creditors or suppliers are interested in the company’s ability to pay
obligations when they become due. They are nonetheless especially interested in the
company's liquidity – its ability to pay short-term obligations.
 5. Government
Governing bodies of the state, especially the tax authorities, are interested in an entity's
financial information for taxation and regulatory purposes. Taxes are computed based
on the results of operations and other tax bases. In general, the state would like to know
how much the taxpayer makes to determine the tax due thereon.
6. Employees
Employees are interested in the company’s profitability and stability. They are after the
ability of the company to pay salaries and provide employee benefits. They may also be
interested in its financial position and performance to assess company expansion
possibilities and career development opportunities.
7. Customers
When there is a long-term involvement or contract between the company and its
customers, the customers become interested in the company’s ability to continue its
existence and maintain stability of operations. This need is also heightened in cases
where the customers depend upon the entity.
For example, a distributor (reseller), the customer in this case, is dependent upon the
manufacturing company from which it purchases the items it resells.
8. General Public
Anyone outside the company such as researchers, students, analysts and others are
interested in the financial statements of a company for some valid reason.
 
The users may be classified into internal and external users.
Internal users refer to managers who use accounting information in making decisions
related to the company's operations.
External users, on the other hand, are not involved in the operations of the company but
hold some financial interest. The external users may be classified further into users
with direct financial interest – owners, investors, creditors; and users
with indirect financial interest – government, employees, customers and the others.
 
*Note: Some authors of accounting books classify owner as internal user.
 
M1-Lesson 4: Forms of
Business Organization
In this lesson, we will discuss about the three basic legal forms of business organization
as follows:
 
 

1. Sole Proprietorship 

A sole proprietorship is owned by a single individual, thus, the owner keeps all the
profits, assumes all the risks and bears all the losses of the business. The tax returns of
a sole proprietorship are filed under the name of the owner and not of the business. The
owner has sole control of the company , the bad news is, the owner also has unlimited
liability. It means that even if the business is already bankrupt, the creditors can still go
after the personal assets of the owner until all the business liabilities has been settled. 
The life of a sole proprietor is limited to the owner's life span and the amount of capital
that can be raised is limited to the amount of the owner's personal wealth. Thus, the
business cannot easily expand or venture new opportunities as it come due to the
limited capital.

2. Partnership

Most of the characteristics of the a proprietorship are the same with a partnership. The
major difference is that in partnership, two or more people contribute money, property or
industry to achieve the partnership goal. Since there are two or more owners, the profits
and losses are divided among themselves based on their partnership agreement.
Partnership decisions should also be agreed upon by all of the partners. However, an
act of a partner which affects third persons will bind the partnership even without
approval of the other partners because all partners are considered mutual agents of the
partnership. For example, if partner A acquired a loan for the partnership without the
knowledge of partners B and C, partners B and C cannot refuse payment on the ground
that they did not approve it since partner A is a mutual agent in the partnership.
Because of this, partnerships are fiduciary in nature. It means that relationship of
partners are based on trust. As such, no person can be admitted to the partnership
without the consent of all the partners.
Partnership can also be general or limited. As stated before, the characteristics of a sole
proprietorship are almost the same with the partnership. Thus, partners also have
unlimited liability. However, a partnership can have a limited partner whose liability is
limited only to his/her capital contribution. This kind of partnership with a limited partner
is called a limited partnership. It means that in the event the limited partnership became
bankrupt, the creditors cannot go after the personal properties of the limited partner. In
this case, the creditors can only go after the general partners. However, since a limited
partner will not share in the partnership losses beyond his/her capital contribution, a
limited partner is also not allowed to participate in managing the operations of the
partnership. 
A partnership without a limited partner is called a general partnership.  In the corporate
world, you can easily identify limited partnerships as they usually have the word Ltd. at
the end of the business name. Ex. ABC Company Ltd.

3. Corporation

A corporation is a juridical person or an artificial person created by law with powers,

attributes and properties expressly authorized by the law. Its personality is distinct from
its owners, meaning, a corporation's assets and liabilities are not the assets and
liabilities of the shareholders. Thus, owners have limited liability and creditors cannot go
after the personal properties of the shareholders in case of bankruptcy.  Corporations
can also enter into contracts in its own name. 
Forming a corporation involves preparing articles of incorporation and bylaws. The
articles of incorporation contains the corporation's name, its intended life, its business
purpose, the number of shares it can issue, etc.  while the bylaws describe how the
corporation regulates its existence such as manner of election of the board of directors,
qualifications, etc. 
The equity of a corporation is divided into shares of stocks and ownership can be easily
transferred by selling these stocks to the shareholders. The earnings of the corporation
is distributed to the shareholders in the form of dividends. However, one of its
disadvantage is that the profit of a corporation is usually taxed twice. One is income tax
when a corporation earned profit and the other one is the final tax on dividend  when it
is declared. It is because corporations are separate and distinct from its shareholders so
they are also being taxed separately.
In large corporations, stockholders and managers are usually separate groups.
In the future modules, we will always assume a corporate form of business. It is
because many financial management issues, such as dividend policy, are unique to
corporations. The corporate type of business is also the one that is usually in need for
outside investors and creditors. However, this is not to say that financial management is
only applicable to corporations as businesses of all types and sizes need financial
management.
Update: Last 2019, the Securities and Exchange Commission already accepts
registrations for a new type of corporation under the Revised Corporation Code which is
called the One-Person Corporation (OPC). This type of corporation combines the
features of a sole proprietorship and a corporation. You can easily determine if a
corporation is a One-Person Corporation because they have the letters OPC at the end
of their business name. Ex. ABC Company OPC. To know more about one-person
corporation, you may read the this article (Links to an external site.) (Links to an
external site.).  

M1- Lesson 5: Types of

Business Operation
An economic entity, usually called a business, is a unit or organization that uses
economic resources in delivering either goods or services to earn profit. 
Business organizations are typically classified into three types according to activities or
operations, namely:
1. Service business
2. Merchandising business
3. Manufacturing business
 
Service Business
This type of business offers no physical product.  This offers professional skills and
expertise of the service provider. It charges the client or customer a fee in exchange of
the service rendered. Typical examples of this business include law firms, accounting
firms, restaurants, hospitals, spas, barbershops, clinics, schools, and banks. 
Merchandising Business
This type of business offers goods to customers. It buys the products it sells at a higher
price than its cost. Usually, the business buys its goods for sale at wholesale price and
sells the same at retail price (definitely higher than the wholesale price to earn profit).
This business is also know as trading or "buy-and-sell" business. A distinguishing
characteristic of this business as compared to manufacturing is that it does not modify
the goods it sells to customers. Typical merchandising businesses include sari-sari
stores, grocery stores, convenience stores, distributors, drug stores, hardware stores
and other resellers.
Manufacturing Business
This type of business offers goods to its customers but unlike a merchandising
business, a manufacturing business buys goods (raw materials) and convert them into
another form (finished goods) before selling them. In short, the business modifies the
goods bought from its supplier before selling them. Examples of this business include
manufacturing companies such as Del Monte Philippines, ACS Manufacturing
Corporation, Lloyds Pharmaceuticals and Universal Robina Corporation.
 

In doing accounting, particularly recording transactions, preparing and interpreting

financial statements, accountants are guided  by principles called "generally accepted
accounting principles" or GAAP. These principles exist to address potential
misunderstanding between the one who prepares and the one who uses the financial
statements. 
As mentioned in the accountingcoach.com,  GAAP is  very much beneficial to both
users and preparers of the reports as it attempts to standardize and regulate accounting
definitions, assumptions and methods. 
The following are the basic generally accepted accounting principles :
 
Separate Entity Concept (Business Entity Concept)
The business entity concept only means that the entity should be viewed as a separate
"person" from the owner. The entity should maintain its identity as separate and distinct
from its owner, manager and employees.
In other words, the business has its own identity set apart from its owners or anyone
else. Personal transactions of the owners, managers, and employees must not be
mixed with transactions of the company.
For example, Aling Nena has a sari-sari store located just in front of her house. Looking
forward to meet her amigas, she is preparing for their get-together. She notices that she
runs out of shampoo so she simply gets a few sachets of her favorite shampoo from her
store. By doing so, is she violating the business entity concept? 
The answer is yes. To follow the business entity concept,  Aling Nena should pay for the
shampoo as personal transactions should be separate from business transactions.
 
Accrual Basis of Accounting
The accrual basis of accounting means that "revenue is recognized when it is earned
regardless of when cash is received and expenses are recognized when  they are
incurred, regardless of when cash is paid".
This basis of accounting allows the setting up receivable for uncollected revenue
and payable for the unpaid expense.  This is the opposite of the usual practice and
convenient way of recognizing revenue during cash collection and expense during cash
payment.
To make it simpler, under accrual basis, income is not the same as cash collections and
expense is different from cash payments. Under accrual basis, revenues and expenses
are recognized when they occur regardless of when the amounts are received or paid.
For example, XYZ Company rendered repair services worth P5,000 to a client on
December 20, 2019. The client paid after 30 days – January 19, 2020.
When should XYZ Company recognize the P5,000 as revenue? Should it be on
December 20, 2019 or January 19, 2020?
Following the meaning of accrual basis, the revenue should be recognized
on December 20, 2019 even if it was not yet collected as of that date. 
Another example, suppose MM Company received its electricity bill of P8,000 for the
month of July 2019 on August 4, 2019 and paid it on its due date, August 10, 2019.
When should the electricity expense be recorded?
The answered should be on July 2019 as the electricity was used in that month.
 
Going Concern Principle
The going concern principle, states that the business will not cease to operate in the
near future. Simply stated, financial reports are prepared on the assumption that  the
entity will continue to operate indefinitely, or at least for another twelve months. 
Financial statements are prepared with the assumption that the entity will continue to
exist in the future, unless otherwise stated.
This is the reason why assets are generally presented in the statement of financial
position at historical cost rather than at fair market value. Another example of going
concern application is that long-term assets are included in the books until they are fully
utilized and retired.
 
Time Period (Periodicity)
The performance of a business can only be determined after wrapping up. Following the
going concern principle, we assume that the business has indefinite existence, how can
we measure the performance of a business?
This assumption answers the question. Time period refers to the reporting period  to
measure the financial performance of a business. This means that the indefinite
existence or life of the business is subdivided into time periods, usually of equal length,
to make reports on the result of business operation as to financial performance,
financial position and cash flows.
Usually, a reporting period is a 12-month period, which can either be an calendar period
or a fiscal period. A calendar year refers to a 12-month period that starts on January 1
and ends on December 31, while a fiscal year refers to any 12-month period that starts
at any day and ends on the day after completing the full year cycle. Example: August 1,
2019-July 31, 2020, April 1, 2020- March 31, 2020
An accounting period is usually a 12-month period – either calendar or fiscal.
Sometimes, this accounting or reporting period is shorter. it can be on a quarterly or
monthly basis, depending on the reportorial requirements and needs of interested
parties.
 
Monetary Unit Assumption
Economic activities must be measured at a specific monetary unit. This follows the
prevailing currency being used in the country where the business operates. In the
Philippines, we measure business transactions using Philippine peso.
As discussed in accountingverse.com, the monetary unit assumption has two
characteristics – quantifiability and stability of the currency.
   Quantifiability means that records should be stated in terms of money, usually in the
currency of the country where the financial statements are prepared. 
   Stability of the dollar (or euro, pound, peso, etc.), a.k.a. stable dollar concept means
that the purchasing power of the said currency is stable or constant and that any
insignificant effect of inflation is ignored.
It is to be noted however that financial statements of a company reporting in the
currency of a hyperinflationary economy (an economy with very high inflation rate) must
be restated, in accordance with applicable accounting standards.
 
Matching Principle
 The matching principle means that revenue is recognized in the period the related
expenses are incurred, and expenses are recognized in the period the related revenue
is earned. Hence, it is  called matching concept. This also calls for the use of accrual
basis of accounting to achieve better matching of revenues and expenses. For example,
if you are a sari-sari store owner, your revenue (sales) must be recognized when the
goods are sold. Accordingly, your goods previously treated as inventories (asset) will be
recognized as expense (cost of sales) on the same period the revenue is recognized.
 
Historical Cost Principle (Cost Principle)
This means that a business transaction should be recorded at the prevailing cost when
it took place. This is the reason why items in the balance sheet (statement if financial
position) are generally presented at historical cost. Nonetheless, some accounts are
measured using other bases such as fair market value, current cost, and discounted
amount. 
 
Revenue Recognition Principle  
Under accrual basis accounting, revenue or income is recognized when earned
regardless of when received.  A revenue is said to be earned  when a product has been
sold or a service has been provided. For example, a company earns P500,000 as
revenue even if it does not receive the full amount or none at all, PROVIDED, that
goods or services have been provided.
 
Expense Recognition Principle 
Also following accrual basis of accounting, expenses are recognized when incurred
regardless of when they are paid. In other words, expenses are recorded when used
(incurred), even if they are not yet paid.
 
Full Disclosure Principle
Some information are important to the decision-making of the potential user such as
investor or creditor to make informed judgments. It is for this reason why these
information must be disclosed fully in the notes to the financial statements. 
As an example, let's say a company is named in a lawsuit that involves one of its
properties valuing at a significant amount of money. When the financial statements are
prepared, it is not clear whether the company will be able to defend itself or whether it
might lose the lawsuit. As a result of these conditions and  following the full disclosure
principle, the lawsuit should be mentioned and described in the notes to the financial
statements.
A company usually lists its significant accounting policies as the first note to its financial
statements to aid the user and interpreter to better understand the financial reports.
 
Materiality
The materiality principle states that an accounting standard can be ignored if the net
result of doing so has such a small impact on the financial statements that a reader of
the financial statements would not be misled.Because of this basic accounting principle
or guideline, an accountant might be allowed to violate another accounting principle if
an amount is insignificant. Professional judgement is needed to decide whether an
amount is insignificant or immaterial.
An example of an obviously immaterial item is the purchase of a P2,500 worth of small
equipment by a highly profitable multi-billion peso company. Because the equipment is
expected to be used for five years, the matching principle directs the accountant to
expense the cost over the five-year period. The materiality guideline allows this
company to violate the matching principle and to expense the entire cost of P2,500 in
the year it is purchased. The justification is that no one would consider it misleading if
the amount of P2,500 is expensed in the first year instead of P500 being expensed in
each of the five years that it is used.
Because of materiality, financial statements usually show amounts rounded to the
nearest peso, to the nearest thousand, or to the nearest million peso depending on the
size of the company. As a proof, you will notice that in the headings of the financial
statements of large companies, there is a phrase stating, "amount in thousands or
millions" like this one:

Im
Image Source: https://cdn.wallstreetmojo.com/wp-content/uploads/2018/05/Consolidated-Financial-Statements-Colgate-CF.png

 
Conservatism
If a situation arises where there are two acceptable alternatives for reporting an item,
conservatism or prudence directs the accountant to choose the alternative that will
result in less net income and/or less asset amount. Also, it directs the company to
anticipate or disclose losses. In other words, conservatism dictates that in preparing
financial reports, assets and revenues should not be overstated, and liabilities and
expenses should not be understated.
For example, potential losses from lawsuits will be reported on the financial statements
or in the notes, but potential gains will not be reported. Also, an accountant may write
inventory down to an amount that is lower than the original cost, but will not write
inventory up to an amount higher than the original cost.