CHAPTER 1

The Nature of Accounting and Its

Business Environment
LESSON 1-1 THE NATURE OFACCOUNTING
Lesson objectives
. define accounting
. describe its nature and function in business
WHAT IS ACCOUNTING?

Accounting is the 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.
The 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.
The Philippine Institute of Certified Public Accountants (PICPA) defines accounting
as 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.

Nature of Accounting
The nature of accounting is in its definition as follows:
1. Accounting is a systematic process.
Process is a series of actions that produce something or that lead to a particular result. As
such, the performance of the four aspects of accounting, which are recording, classifying,
summarizing, and interpreting, leads to communicating to its users the relevant financial
information needed by the parties interested.
2. Accounting is an art.
Art is a skill acquired by experience, study, or observation. It is also defined as an
occupation requiring knowledge or skill. The four aspects of accounting require both
knowledge and skill through experience, study, or observation as a means to produce the
key end product which are the financial reports.
3. Accounting is a service activity.
Service is the occupation or function of serving. Activity is something that is done as work
or for a particular purpose. Combining the meaning of the two words. accounting is a work
or occupation for serving a particular purpose. Hence, since its purpose is to provide
financial information, the data that it will process in terms of the four aspects of accounting
should be expressed in monetary terms. In short, it is interested in activities that can be
measured and expressed in terms of the value of money.
Four Aspects of Accounting

1. Recording — writing down of business transactions chronologically in the books of

account 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 account 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. BV 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. This makes accounting
the language of business.

The Basic Function of Accounting in Business

The aspects of accounting can be summed up to one basic function, which is the
generation of relevant and timely financial information for interested parties. The data
provided by accountants can assist investors, government agencies, creditors, and
management in making sound decisions. The financial information provided about the
activities of an economic organization makes it easily comprehensible for users to assess
its financial position as of a 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.

LESSON 1-2 HISTORY OF ACCOUNTING

Lesson objective
. know the origin and history of accounting

A BRIEF HISTORY OF ACCOUNTING

"It is believed that the very origins of writing itself may have developed out of early marks
used to keep account of goods at ancient warehouses more than 5,300 years ago. The notion
that pre-numerical counting systems pre-dated even written language didn't come as a
surprise to many historians and archaeologists who have long since recognized that the
history of human civilization is largely indistinguishable from the history of commerce.”

Ancient Accounting in Egypt, Mesopotamia, Greece, and Rome

The history of accounting dates back to ancient times. The abacus which
functioned as a calculator in the ancient times, was developed by the Sumerians in 5,000
BCE followed by the papyrus which was developed by ancient Egyptians in 4,000 BCE.
The papyrus not only allowed recording of commercial transactions but also the
transcription of religious text, music, literature, and more. In Egypt, archaeologist Dr.
Gunter Dreyer Of the German Institute of Archaeology unearthed clay tablets considered
to be among the oldest written tax accounting records. In the tomb of King Scorpion I in
Egypt, he discovered old stone labels believed to date back to 3,000 BCE or around 5,300
years ago. These old stone labels were complete with marks representing accounts of oil
and linens which were believed to be paid to the king as taxes.

Mesopotamia had clay tokens and clay tablets to record their loans, herds, crops, and
system of trade. The scribes who performed extensive duties in writing and recording in the
Mesopotamian civilization are the equivalent of present-day accountants. Aside from writing
down commercial transactions, scribes assured that the agreements were in compliance with
the detailed code requirements for commercial transactions.

The Greeks also made significant contributions to the development of accounting. In

600 BCE, they introduced money in the form of coins. Moreover, they adopted the Phoenician
writing system and invented the Greek alphabet which they used to facilitate record-keeping.
As early ng those times, bankers in Greece offered credit and helped people transfer funds to
banks in other cities as evidenced by the bankers' book of account. It was the same in Rome
where accounting helped establish their finance and legal system. In fact, the Romans
introduced the use of an annual budget which coordinated estimated revenues and taxes paid
by the citizen in relation to the nation’s expenditures. A cash book was maintained by
households for their expenses.

In England, William the Conqueror took possession of all properties in the name of
the king upon his invasion. In 1086, the Domesday Book contained all the real estate surveyed
by William the Conqueror and the taxes due to them. To date, the Pipe Roll or the Great Roll
of the Exchequer is the most ancient surviving accounting record in the English language. This
contains the yearly accounting of rents, fines, and taxes due to the King of England, from 1130
to 1830.

14th Century — The Birth of Double-Entry Bookkeeping

During the 14th century, Luca Pacioli of Italy, otherwise known as Friar Luca dal
Borgo, a mathematician, friend and contemporary of Leonardo da Vinci, and considered to
be the "Father of Accounting' wrote Summa de Arithmetica, Geometria, Proportioni et
Proportionalita (Everything About Arithmetic, Geometry and Proportion). One section of
this book, De Computis et Scripturis (Of Reckonings and Writings), is composed of 36 short
chapters that describe bookkeeping. The accounting cycle, similar to the modern day
accounting cycle is also included in this book. The book also explains the extensively used
balance sheet of today, the method of using memorandums, journals and ledgers, the use of
accounts such as assets, liabilities, owner's equity, revenue and expenses, year-end closing
entries, and the use of the trial balance to prove a balanced ledger.

Pacioli credited Benedetto Cotrugli, for the original idea of the double-entry
bookkeeping. Cotrugli's manuscript of Della Mercatura et del Mercante Perfetto (of Trading
and The Perfect Trader), which contains a brief description of the double-entry of
bookkeeping, was never printed. Actually, not only Luca Pacioli, but the Italians are broadly
recognized to be the father of accounting for their marked contribution to the improvement
of trade and commerce. The business-minded early capitalistic Venetian merchants used
double-entry system of recording in the late 15th century to calculate their earnings and
profits.

19th Century — The Dawn of Modern Accounting in Europe and

America

Domination of the Theories of accounts (rather than accounting theories) marked not
only the beginning but also the latter part of the nineteenth century. In England, the Industrial
Revolution which replaced hand tools with machine or power tools, otherwise known as the
factory system, transformed accounting into an actual profession. Businesses continued to
expand requiring the expertise of accountants to gain corporate control of their flourishing
business.

In Scotland, Queen Victoria granted n royal charter to the Institute of Accountants

in Glasgow on July 6, 1854, thereby creating the profession of chartered accountant
(CA). Thus, accounting became formal profession. In the latter part of the 19th century,
because large amounts of British capital were invested in flourishing industries in the
United States, Scottish or British chartered accountants were sent to the United States to
audit British investments. Some of these accountants decided to stay in America and
became provenances of various accounting firms, which they set up to practice their
profession. The year 1887 saw the birth of the first national US accounting society.
The American Association of Public Accountants which provided formal certification
process for accountants was the predecessor of the present American Institute of Certified
Public Accountants (AICPA).

20th Century — The Evolution of Modern Accounting Standards

The American Institute of Certified Public Accountants (AICPA), the first national
professional association for Certified Public Accountants (CPA), was formed in the young
but prosperous nation of the United States. Because of the economic depression, the
Securities and Exchange Commission (SEC) was formed. Periodic reports vouched by
certified public accountants were filed by all publicly-traded companies who had to register
with the SEC before selling their securities to the public. Thus, the AICPA was tasked to set
the accounting and auditing standards for these reports until the establishment of the
Financial Accounting Standards Board (FASB) in 1973. The FASB is the result of the
demand for more reliable and comparable financial reporting by the Congress and SEC. Thus,
the FASB and the Governmental Accounting Standards Board (GASB) are currently two of
the significant authorities establishing the generally accepted accounting principles (GAAP)
in the US. On the other hand, in response to the continuing expansion of businesses, large
accounting firms offered consultancy services aside from their auditing function.

The Information Age

The Information Age, otherwise known as the Computer Age, Digital Age, or New
Media Age, has brought about a significant change in the work load of accountants. Manual,
tedious and time-consuming tasks were replaced by faster and more accurate computer
methods. Transactions can be consummated online with the help of the internet. Various
software applications in accounting have been developed to expedite procedures and
accommodate the numerous needs and demands of the different businesses.

21st Century — Accounting in the Modern Times

The century opened with the replacement of the International Accounting Standards
Committee (IASC) by the International Accounting Standards Board (IASB) established
in January 2001. In the same year, the Enron Scandal, the greatest corporate fraud case
recorded in American history, caused Arthur Andersen, one of the top audit firms in the
United States to close business. In order to protect investors from corporate misinformation,
the Sarbanes-Oxley Act was passed by the US Congress in 2002. This imposed tougher
restrictions on accountants conducting consultancy services.

The year '2008 witnessed tougher times with the economic recession in the United
States. In response to the Great Recession, the Dodd-Frank Act was signed into federal law
on July 21, 2010. This contains sixteen major areas of reform, including Financial Stability,
Orderly Liquidation Authority, Transfer of Powers to the Comptroller, the FDIC, and the
Fed, Regulation of Advisers to Hedge Funds and Others, Insurance, Improvements to
Regulation, Wall Street Transparency and Accountability, Payment, Clearing and
Settlement Supervision, Bureau of Consumer Financial Protection, Federal Reserve System
Provisions, Improving Access to Mainstream Financial Institutions, Pay It Back Act,
Mortgage Reform, and Anti-Predatory Lending Act.

With constant developments in modern technology and the globalization of

businesses, accountants continue to cope up with the changing trends. Many countries
including the Philippines have adopted the. International Accounting Standards (IAS) and
International Financial Reporting Standards (IFRS) in order to support comparability and
understandability of financial statements across the globe. As a result, the accountants of
today face greater and more complicated responsibilities. In addition, technology today
reduces the time, effort, and cost of recordkeeping, minimizes errors as well as processes,
and summarizes large volumes of data input. As such, accountants must always be updated
with the latest innovations affecting their profession.
 LESSON 1-3 THE BUSINESS ENVIRONMENT
Lesson Objective
. differentiate the branches of accounting
. explain the types of services rendered in each brand of accounting
. know the different types of business organization
. know the legal requirement of formation of a business
. classify the different types of business operations

THE DIFFERENT BRANCHES OF ACCOUNTING

1. Financial Accounting
Financial accounting deals with the theoretical framework covering accounting
principles and concepts relative to measurement and valuation as applied to assets,
liabilities, stockholder's equity, retained earnings, revenue, and expense accounts in relation
to the preparation and presentation of financial statements. These financial statements
include disclosure requirements as governed by the generally accepted accounting principles
(GAAP).
The financial information provided by financial accounting is used for decision making
by both internal and external users. Internal users include owners, shareholders, management,
and employees while external users include creditors, potential investors, and government
agencies.

2. Management Accounting

The Institute of Management Accountants (IMA) defines management

accounting as a profession that involves partnering in management decision
making, devising planning and performance management systems, and providing
expertise in financial reporting and control to assist management in the
formulation and implementation of an organization's strategy.
3. Government Accounting
Section 109 of Presidential Decree (PI)) No. 1445 states that government accounting
encompasses the process of analyzing, classifying, summarizing, and communicating all
transactions involving the receipt and disposition of government funds and property, and
interpreting the results thereof. The agencies responsible in performing government
accounting functions are the Commission of Audit (COA), the Department of Budget and
Management (DBM), and the Bureau of Treasury (BTr).
4. Auditing
Auditing is the examination and review of accounting reports in order to ascertain their
fairness, propriety, and reliability. The independent auditor's opinion provides reasonable
assurance that the financial statements under examination fairly present the company's
financial position and results of operation in accordance with the generally accepted
accounting principles (GAAP).
5. Tax Accounting
Tax services provided by accountants include the preparation of monthly value added
tax, percentage tax, expanded withholding tax returns, quarterly and annual tax returns, and
any other taxes applicable to business. Accountants work closely with clients in order to
avoid tax problems with the Bureau of Internal Revenue (BIR) and other local agencies
through proper tax compliance while advising clients about ways and measures to minimize
taxes.
6. Cost Accounting
Cost accounting includes the collection, determination, allocation, assessment,
interpretation, and control of cost data, particularly the cost of production in a manufacturing
concern. The cost of production includes the raw materials, direct labor, factory overhead,
and all other costs involved incident in each stage of production of the finished goods.

7. Accounting Education
Accounting education involves planned grading and formal teaching in an educational
institution. The professional accountant imparts knowledge to students enrolled in an
accounting subject either in basic accounting or in higher accounting subjects. Accountants
in the academe usually take post graduate studies to achieve the required tenure.

8. Accounting Research
Accounting research involves conducting a careful and diligent study aimed at
discovering and interpreting facts, revising accepted theories in the light of new facts, or the
practical application of such new or revised theories for the generation of a new knowledge.
It includes collecting information about a particular subject in order to decide and
implement new standards in accounting, presenting current events that might affect the
profession, or discovering new theories that will have an impact on existing accounting
knowledge.
Users of Financial Information
Internal Users
Internal users 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.

1. Investors/ Owners/ Stockholders

These parties provide the financial resources to keep the business going. They decide
whether to invest or not depending on the estimated amount of income on the investment.
Upon investment, they would want to know the financial position or results of operation of
their business investment.
2. Management
Organizational managers use financial information to set goals for their companies.
Managers evaluate their progress towards these goals and use financial data as a guide for
future management actions.
3. Employees
Although the employees are not directly involved in the decision making of the
company, they are nonetheless interested in the financial information of the company to
determine if they have a future in the company.
 External Users
External users are secondary users of financial information who are parties outside the
company. They may not be directly involved in the company's operations but their decisions
may significantly affect the business entity.

1. Financial Institutions/ Creditors

Before extending credit, financial institutions use financial information to determine
the capacity of the business organization to pay its obligations and their interests at the
appropriate time.

2. Government
Financial information is important for tax purposes and in checking of compliance with
Securities and Exchange Commission (SEC) requirements.

3. Potential Investors/ Creditors

Before making an investment or extending credit, potential investors or
creditors may not only be interested in the company's current financial position
and results of operations, but also in the company's financial history. This should
give them the assurance that their investment will yield a reasonable rate of return
or the credit extended will be paid within a reasonable period of time.

Types of Business Organizations

1. Sole/ Single Proprietorship is a business owned and managed by only one
person.

Advantages
a. There are minimal costs and requirements in the formation.
b. The owner can withdraw the assets and profits of the business anytime at his
or her own discretion.
c. Decision making is solely in the hands of the owner.
d. The duration of the life of the business solely depends on its owner.

Disadvantages
a. Resources are limited as the capital is provided only by the owner.
b. The liability of the owner is unlimited as he or she is accountable to all
creditors of the business.
c. Infusion of knowledge in the management of the business is limited to one
person only, which is the owner.

2. Partnership is a 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.

Advantages
a. There are minimal costs and requirements in the formation.
b. There are more funds contributed from the investment of the partners.
 c. There is infusion of more knowledge, experience, and skills from two or more
partners.
d. There can be division of labor between or among partners.

Disadvantages
a. The partners are liable for the actions of each partner as a result of mutual
agency.
b. A general partner has unlimited liability if the other partners are limited
partners or are insolvent.
c. Disagreement between or among partners can lead to the withdrawal of one
or more partners.
d. The death, retirement, withdrawal, or incapacity of a partner results in
the dissolution of the partnership.
e. Admission of a new partner depends upon the approval of the other partners.

3. Corporation is a 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.

Advantages
a. The stockholders only have limited liability, as their liability extends only up
to the amount of their capital investment.
b. A corporation has continuous existence as its life is indefinite.
c. There is more infusion of funds from the stockholders or investors.
d. Shares of stocks can be transferred without the consent of other shareholders.
e. Management of the corporation is vested upon its board of directors.

Disadvantages

a. A corporation entails many requirements and is more costly than a

partnership.
b. The government exercises strict control over corporations and imposes high
taxes.
c. Shareholders have little or no participation in the
management of the corporation.
d. Distribution of net income depends upon the declaration of dividends by the
board of directors.
e. In large corporations, there is formal or impersonal relationship between
employees and management due to the big number of employees. Hence, chances of creating
a personal and friendly atmosphere in the corporate setting are minimal.

4. Cooperatives
Under Section 3 of Republic Act 6938, a cooperative is 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.
In short, a cooperative is an association of small producers and consumers who come
together voluntarily to form a business which they own, manage, and patronize.
 Advantages
a. The prices of products offered to consumers are lower due to direct purchases
of cooperative members from producers or manufacturers.
b. Cooperatives are managed by the members themselves; thus, saving on
management costs which leads to lower prices of products inuring to the benefit of the
consumers.

Disadvantages
a. There is limited capital due to underprivileged members.
b. The cooperative is strictly for members only and shares cannot be transferred
to non-members.
c. Lack of efficient management as it is managed only by its members.

Legal Requirements in the Formation of a Business

The sole proprietorship is the easiest business to register. It is registered with the
Department of Trade and Industry (DTI) under its Bureau of Trade Regulation and Consumer
Protection.

For a partnership, the business is registered with the Securities and Exchange
Commission (SEC) upon submission of the following documents:
a. Proposed Articles of Partnership
b. Name Verification Slip
c. Bank Certificate Deposit
d. Alien Certificate of Registration, Special Investors Resident Visa, or proof of
other types of visa (in case of foreigners)
e. Proof of Inward Remittance (in case of non-resident aliens)

For a corporation, the following are the incorporation documents required to be

filed With the Securities and Exchange Commission (SEC):
a. Articles of Incorporation
b. By-laws
c. Treasurer's Affidavit which should state compliance with the authorized
subscribed and paid-up capital stock requirements.
d. Bank Certificate which should state that the paid-up capital portion of the
authorized capital stock has been deposited to the issuing bank

What should be stated upon registration of a corporation?

a. The name of the. corporation which must not be identical, or deceptively or
confusingly similar to any existing corporation
b. The purpose of the corporation
c. Principal office of the corporation
d. The term or life of the corporation, which should not exceed fifty (50) years.
This Corporate lifetime may, however, be extended for another fifty (50) years but the
extension must not be effected earlier than five (5) years before the expiration of its term.

For a cooperative, the business is registered with the Cooperative Development

Authority (CDA) upon submission of the following documents:
a. Economic Survey
 b. Notarized Articles of Cooperation and By-Laws
c. Bonds of accountable officer or officers
d. Notarized sworn statement of the treasurer certifying that the required
subscription and payment of the authorized share capital and paid-up capital have been
fulfilled.

Three Types of Business Activities/ Operations

1. Service is a type of business operation engaged in the rendering of services.
A service type of business earns based on the skill or quality of service it offers. In order for
the business to grow, its people or employees have to be trained. For example, a well known
hair cutter cannot perform all the hair and makeup services to his or her customers. He/she
must train employees to replicate the quality of the service he/she renders. Constant
monitoring, evaluating, and updating of knowledge of the staff are necessary. He/she has to
continuously maintain, if not improve, the quality of service offered to his/her customers.

Examples: dental clinic, barbershop, laundry service

2. Trading/ Merchandising is a type of business engaged in the buying

and selling of goods. Merchandising includes the process of managing and marketing
the products sold to its customers. Sales have to be optimized in order to make money.
Customer demands have to be satisfied with the quality of products sold. The tedious
processes of forecasting, purchasing, pricing, and marketing of products in order to
generate sales are essential in the trading or merchandising business.

Examples: grocery, sari-sari store

3. Manufacturing is engaged in the production of items to be sold. It

involves the purchasing and converting of raw materials to finished goods. This type
of business incurs overhead costs aside from the wages and materials used in the
production of goods. A rise in price in one of these costs causes an increase in the
price of goods produced. Aside from this, there are certain expenses incurred even
during periods of non-manufacturing such as rent, insurance, worker benefits, and
machine depreciation. Hence, careful planning is involved in manufacturing.

Examples: shoe factory, food processing