CHAPTER
ACCOUNTING IN ACTION
The Nature of Accounting and Its Business
Environment
ACCOUNTING
is a systematic process of measuring and reporting relevant
financial information about the activities of an economic
organization or unit. Its underlying purpose is to provide
financial information. It is capable of being expressed in
monetary terms.
American Institute of Certified Public Accountants (AICPA)
defines Accounting as the art of recording, classifying and
summarizing in a significant manner and in terms of money,
transaction, and events, which are in part at least of a financial
character, and interpreting the result thereof.
Philippine Institute of Certified Public Accountants
(PICPA) defines accounting as a service activity. Its function is
to provide quantitative information, primary financial in nature,
about economic entities, that is intended to be useful in decision
making.
The Basic Function of Accounting in Business
- generation of relevant and timely financial
information for interested parties.
The financial information provided about the
activities of an economic organization makes it
easily comprehensible for users to assess its financial
position as of given time and results of operations for
a given period. This qualitative and quantitative
financial data used by users relating to specific
business decisions makes accounting THE
LANGUAGE OF BUSINESS.
Four Aspects of Accounting
1. Recording- writing down of business transactions
chronologically in the books of accounts as they transpire.
2. Classifying – sorting similar and related business
transactions into the three categories of assets, liabilities
and owner’s equity.
3. Summarizing – preparing the financial statements from
the transactions recorded in the books of accounts that are
designed to meet the information needs of its users.
4. Interpreting – representing the qualitative and
quantitative financial information about the business
transactions in a language comprehensible to the users of
financial statements. By interpreting the data in the
financial statements, users are able to determine the
financial standing of the company as well as its stability
and growth potential. Users interpret financial
information relating to specific business decisions.
ILLUSTRATION 1-1
THE ACCOUNTING PROCESS
Communication
Identification Recording Account
ing
Reports
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Fre acCau nholm
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200
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Prepare
accounting reports
SOFTBYTE
Select economic events Record, classify, Annual Report
(transactions) and summarize
Analyse and interpret
for users
Users of Financial Information
1. Internal Users –
- They are the primary users of financial information who
are inside the reporting entity and are directly involved in
managing the company’s daily operations. They are the
decision makers who make the strategic and operational
decisions for the company.
Investors/Owners/Stockholders; Management; Employees
2. External Users
They are the secondary users of financial information who
are the parties outside the company. They may not be
directly involved in the company’s operations but their
decisions may significantly affect the business entity.
Financial Institutions/ Creditors; Government; Potential
Investors/ Creditors
ILLUSTRATION 1-2
QUESTIONS ASKED BY INTERNAL USERS
What is the cost of manufacturing
Is cash sufficient to pay bills? each unit of product?
Can we afford to give employees Which product line is the most
pay raises this year? profitable?
ILLUSTRATION 1-3
QUESTIONS ASKED BY EXTERNAL USERS
How does the company compare in
Is the company earning size and profitability with its
satisfactory income? competitors?
What do we
do if they
catch us?
Will the company be able to pay its debts as they come due?
Accounting Concepts and Principles
Generally Accepted Accounting Principles (GAAP)
These are broad, general statements or rules and
procedures that serve as guides in the practice of accounting.
These are standards, assumptions and concepts with
general acceptability.
These are measurement techniques and standards used in
the presentation and preparation of financial statements.
Accounting system comprises the methods used by a
business to keep records of its financial activities and to
summarize these accounts in periodic accounting reports.
Transaction is a completed action which can be expressed
in terms of money.
GAAP
Generally Accepted Accounting Principles
Cost Principle
The cost principle dictates that assets are
recorded at their cost.
Cost is the value exchanged at the time something
is acquired.
Cost is used because it is both relevant and
reliable.
ASSUMPTIONS
1. Going Concern - assumes organization will
continue into foreseeable future.
2. Monetary Unit - only transaction data that can
be expressed in terms of money is included in
the accounting records.
3. Economic Entity - includes any organization
or unit in society.
4. Accrual Basis – transactions are recorded
regardless if cash is paid or cash is received
Basic Accounting Principles
1. Objectivity Principle
2. Historical Cost
3. Accrual Principle
4. Adequate Disclosure
5. Materiality
6. Consistency
Types of Business Organization
1. Sole or Single Proprietorship
- business owned and managed by only one person.
2. Partnership
- business organization owned and managed by two or more
people who agree to contribute money, property or industry to
a common fund for the purpose of earning a profit.
3. Corporation
- form of business organization managed by an elected board of
directors. The investors are called stockholders and the unit of
ownership is called share of stock.
4. Cooperative
- a duly registered association of persons with a common bond
of interest , who have voluntarily joined together to achieve a
lawful common social or economic end, making equitable
contributions to the capital required and accepting a fair share
of the risks and benefits of the undertaking in accordance with
universally accepted cooperative principles.
Three Types of Business Activities/Operations
1. Service - type of business operation engaged in the
rendering of services. Example: barber shop; dental
clinic
2. Trading/Merchandising - type of business
engaged in the buying and selling of goods and
includes the process of managing and marketing of
products sold.
Examples: sari sari store; grocery
3. Manufacturing - engaged in the production of items
to be sold. It involves the purchasing and converting of
raw materials to finished goods.
Exercise:
Instruction: Determine the type of business organization formed in
each case. Then, determine the type of activities performed by the
business.
1.Jack and Jill were classmates since elementary. They went to college
together and recently passed the bar exams. They decided to form Jack
and Jill Law Firm.
2.Bill Ty, a marketing student is looking for business to help him fund
his studies. He decides to rent a stall near the university and hire a
saleslady to help him sell the school supplies he buys from Divisoria.
Mark-up is usually 25% of the cost.
3.Juan dela Cruz and Pedro Lina are both engaged in the production of
soaps and shampoos. They decided to join their businesses together in
order to expand their market.
4.Alibaba, Zeus and three more friends who are mechanical engineers
decided to open a plant where they can produce machines to be sold to
big factories. They decided to invite incorporators to generate more
funds.
ILLUSTRATION 1-5
BASIC ACCOUNTING EQUATION
The Basic Accounting Equation
Assets = Liabilities + Owner’s Equity
ASSETS AS A BUILDING BLOCK
Assets are resources owned by a business.
They are things of value used in carrying
out such activities as production and
exchange.
LIABILITIES AS A BUILDING BLOCK
Liabilities
are claims against assets.
They are existing debts and obligations.
OWNER’S EQUITY AS
A BUILDING BLOCK
Owner’s Equity is equal to total assets minus
total liabilities.
Owner’s Equity represents the ownership claim
on total assets.
Subdivisions of Owner’s Equity:
1. Capital
2. Drawings
3. Revenues
4. Expenses
INVESTMENTS BY OWNERS
AS A BUILDING BLOCK
Investments by owner are the assets put into
the business by the owner.
These investments in the business increase
owner’s equity.
DRAWINGS AS A
BUILDING BLOCK
Drawings are withdrawals of cash or other
assets by the owner for personal use.
Drawings decrease total owner’s equity.
REVENUES AS A
BUILDING BLOCK
Revenues are the gross increases in owner’s
equity resulting from business activities entered
into for the purpose of earning income.
Revenues may result from sale of merchandise,
performance of services, rental of property, or
lending of money.
Revenues usually result in an increase in an asset.
EXPENSES AS A
BUILDING BLOCK
Expenses are the decreases in owner’s equity that
result from operating the business.
Expenses are the cost of assets consumed or
services used in the process of earning revenue.
Examples of expenses include utility expense, rent
expense, and supplies expense.
ILLUSTRATION 1-6
INCREASES AND DECREASES IN
OWNER’S EQUITY
INCREASES DECREASES
Investments
Investments Withdrawals
Withdrawals
by
byOwner
Owner by
byOwner
Owner
Owner’s
Equity
Revenues
Revenues Expenses
Expenses
