FUNDAMENTALS OF ACCOUNTING

Chapter 1 - Introduction to Accounting

Expectation
Specifically, this chapter will help you to:
1. define accounting;
2. describe the nature of accounting;
3. explain the functions of accounting in business;
4. narrate the history/origin of accounting; and
5. cite specific examples in which accounting is used in making business decisions.

Brief Introduction

A Numbers Game

There are numerous successful businesses both locally and internationally. Some top-of-
mind companies include Microsoft, Apple, Coca-Cola, and Procter & Gamble. Here in the
Philippines, surging businesses include Puregold, Petron, Globe, and many others.
Obviously, these businesses offer products which are distinct from one another. Have you
ever wondered about the secret formula for a company’s success? This discussion can go on for
days without yielding a definite answer. Nonetheless, there is a common factor among these
businesses that contribute to their success – accounting.
Accounting involves the process of identifying, recording, and communicating financial
information to internal and external users alike. It helps quantify data for easier interpretation.
Numbers is the language of business. In order to efficiently manage your business, you need to
know numbers. After gathering the data on the performance of the company, these are summarized
and used as a guide for future decision-making. Accounting is a tool used in achieving all these
goals.
How will the manager know if the company is doing well? How can he/she know if
additional investment is needed in a particular segment of the company? If not for accounting,
managers will still be making decisions not based on solid foundation.

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 Lecture
Accounting is, broadly speaking, a system that helps businesses track events that
affect
them. It is the process of IDENTIFYING, RECORDING, and COMMUNICATING
economic events of an organization to interested users.
Almost all companies allot a significant amount of resources to the accounting process
since it aids them in improving their business. For example, the sale of Toyota cars is identified as
an economic event that affects the company. The accountant will record this transaction and
consolidate all records by the end of the month. The consolidated records can be used by the top
management to identify potential problems encountered by the company. This can also be used to
attract investors. Clearly, accounting process is very beneficial to a company.

The Accounting Process

Identifying - this involves selecting economic events that are relevant to a particular
business transaction. The economic events of an organization are referred to as transactions.

Examples of economic events or transactions - In a bakery business:

sales of bread and other bakery products
purchases of flour that will be used for baking
purchases of trucks needed to deliver the products

Note:To identify relevant economic events, there should be a transfer of things with value.
Normally, for the purchase of flour, cash or money is exchange for it. The cash and flour
bothhave value making the purchase a relevant economic event.

Recording - this involves keeping a chronological diary of events that are

measured in
pesos.Thediary referred to in the definition are the journals and ledgers which will be
discussed in futuremodules.
Communicating - occurs through the preparation and distribution of financial
statementsand other accounting reports.

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NATURE OF ACCOUNTING

According to Accounting Theory (http://accountingtheory.weebly.com/nature-and-scope-

of-accounting.html): “Accounting is a systematic recording of financial transactions and the
presentation of the related information to appropriate persons.” Based on this definition we
can derive the following basic features of accounting:

Accounting is a service activity. Accounting provides assistance to decision makers

by providing them financial reports that will guide them in coming up with sound decisions.

Accounting is a process. A process refers to the method of performing any

specific
job step by step according to the objectives or targets. Accounting is identified as a process,
as it performs the specific task of collecting, processing and communicating financial
information. In doing so, it follows some definite steps like the collection, recording,
classification, summarization, finalization, and reporting of financial data.

Accounting is both an art and a discipline. Accounting is the art of recording,

classifying, summarizing and finalizing financial data. The word ‘art’ refers to the way
something isperformed. It is behavioral knowledge involving a certain creativity and skill to
help us attain some specific objectives. Accounting is a systematic method consisting of
definite techniques and itsproper application requires skill and expertise. So by nature,
accounting is an art. And because itfollows certain standards and professional ethics, it is also
a discipline.

Accounting deals with financial information and transactions. Accounting

records financial transactions and data, classifies these and finalizes their results given
for a specified period of time, as needed by their users. At every stage, from start to
finish, accounting deals with financial information and financial information only. It
does not deal with non- monetary or non-financial aspects of such information.

Accounting is a means and not an end. As mentioned earlier, accounting is a

tool
to achieve specific objectives. It is not objective itself. Imagine that you dream to go to
Paris someday. Accounting can be thought of as the plane that will bring you to your
destination.
Accounting is an information system. Accounting is recognized and
characterized
as a storehouse of information. As a service function, it collects processes and
communicates financial information of any entity. This discipline of knowledge has
evolved to meet the need for financial information as required by various interested
groups.

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FUNCTION OF ACCOUNTING IN BUSINESS

Why accounting is considered as the language of business?

Accounting is the means by which business information is communicated to business

owners and stakeholders. The role of accounting in business is to provide information for
managers and owners to use in operating the business. In addition, accounting
information allows business owners to assess the efficiency and effectiveness of their
business operations. Prepared accounting reports can be compared with industry
standards or to a leading competitor to determine how the business is doing. Business
owners may also use historical financial accounting statements to create trends for
analyzing and forecasting future sales.
Accounting helps the users of these financial reports to see the true picture of the business in
financial terms. In order for a business to survive, it is important that a business owner or
manager be well-informed.

Let us now discuss the function of accounting in business.

Mr. Juan is a retired government employee who is good at baking. One day he decides to
put up a bakery shop in your barangay. He renovates a portion of his house to serve as the area for
the production of bread. He purchases baking equipment and raw materials to produce five
different types of bread. Mr. Juan also hires Jose to help him with the baking and, at the same time,
to be in-charge of sales. Mr. Juan pays Jose on a weekly basis. Every day, Mr. Juan’s wife deposits
the daily cash sales in their bank account at XY Savings Bank. With the help of accounting, what
possible decisions or questions of Mr. Juan can accounting provide an answer to?

Possible Answers:
• Is my business earning? (profitability)
• How much daily or monthly sales do I need in order to recover my fixed cost? (break-
even)
• Do I need to hire additional workers to help me with my production?
• Can I afford to set up a new store in another place? Where do I get the funds?
• Can I afford to pay a bank loan?

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HISTORY OF ACCOUNTING

Accounting is as old as civilization itself. It has evolved in response to various social and
economic needs of men. Accounting started as a simple recording of repetitive exchanges. The
history of accounting is often seen as indistinguishable from the history of finance and business.
Following is the evolution of accounting:

The Cradle of Civilization

Around 3600 B.C., record-keeping was already common from Mesopotamia, China and
India to Central and South America. The oldest evidence of this practice was the “clay
tablet” of Mesopotamia which dealt with commercial transactions at the time such as listing
of accounts receivable and accounts payable. This is also the era that the accountant is
called the eye and the ear of the king.

14th Century - Double-Entry Bookkeeping

The most important event in accounting history is generally considered to be the

dissemination of double entry bookkeeping by Luca Pacioli (‘The Father of Accounting’) in
14th century Italy. Pacioli was much revered in his day, and was a friend and contemporary of
Leonardo da Vinci. The Italians of the 14th to 16th centuries are widely acknowledged as the
fathers of modern accounting and were the first to commonly use Arabic numerals, rather
than Roman, for tracking business accounts. Luca Pacioli wrote Summa de Arithmetica, the
first book published that contained a detailed chapter on double-entry bookkeeping.

French Revolution (1700s)

The thorough study of accounting and development of accounting theory began during this
period. Social upheavals affecting government, finances, laws, customs and business had
greatly influenced the development of accounting.

The Industrial Revolution (1760-1830)

Mass production and the great importance of fixed assets were given attention during this
period.

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19th Century – The Beginnings of Modern Accounting in Europe and America

The modern, formal accounting profession emerged in Scotland in 1854 when Queen
Victoria granted a Royal Charter to the Institute of Accountants in Glasgow, creating
the profession of the Chartered Accountant (CA).

In the late 1800s, chartered accountants from Scotland and Britain came to the U.S. to audit
British investments. Some of these accountants stayed in the U.S., setting up accounting
practices and becoming the origins of several U.S. accounting firms. The first national U.S.
accounting society was set up in 1887. The American Association of Public Accountants was
the forerunner to the current American Institute of Certified Public Accountants (AICPA).

In this period rapid changes in accounting practice and reports were made. Accounting
standards to be observed by accounting professionals were promulgated. Notable practices
such as mergers, acquisitions and growth of multinational corporations were developed. A
merger is when one company takes over all the operations of another business entity
resulting in the dissolution of another business. Businesses expanded by acquiring other
companies. These types of transactions have challenged accounting professionals to
develop new standards that will address accounting issues related to these business
combinations.

The Present - The Development of Modern Accounting Standards and

Commerce

The accounting profession in the 20th century developed around state requirements for
financial statement audits. Beyond the industry's self-regulation, the government also sets
accounting standards, through laws and agencies such as the Securities and Exchange
Commission (SEC). As economies worldwide continued to globalize, accounting regulatory
bodies required accounting practitioners to observe International Accounting Standards.
This is to assure transparency and reliability, and to obtain greater confidence on
accounting information used by global investors.

Nowadays, investors seek investment opportunities all over the world. To remain competitive,
businesses everywhere feel the need to operate globally. The trend now for accounting
professionals is to observe one single set of global accounting standards in order to have
greater transparency and comparability of financial data across borders.

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