MGT 111- Principles of Accounting Instructor: HDMiranda

CHAPTER 1

INTRODUCTION TO ACCOUNTING

Every individual or group in society must make economic decisions about the future. One example is a manager
of a company who has to determine which product or products are saleable. This information is necessary for a manager
who has to decide whether to stop selling them to customers. Others will make investments only if a company is
financially sound. National and local governments need accounting information for tax purposes. Non-profit entities such
as churches, civic and charitable organizations need meaningful and easily understood economic and accounting
information for planning and proper implementation of their programs. Because accountants are known for their financial
and analytical capabilities, they are often asked to analyse the available financial data for clues that will serve as guides to
the future.

BASIC CONCEPTS OF ACCOUNTING

BRIEF HISTORY OF ACCOUNTING

Accounting traces its roots to the Middle East region, where as early as 8500 BC. Tradesmen use clay
objects to represent commodities such as flocks of sheep, jars of spices and oil, bolts of clothing and other goods.
Some archaeologists later unearthed clay tablets marked with symbols and other writings and interpreted them to
mean records of goods sold and other statistics kept at that time.

The ancient civilizations of Babylon, Greece and Egypt also used clay tablets (in late years, papyri were
used as the medium for record keeping). These records show wage payments, material requisitions and costs of
labor, which only shows that accounting has already been in used even during Biblical times.

In 1494, Friar Luca Pacioli wrote a book which contains discussions on the double-entry bookkeeping
system. The book was entitled Summa de Arithmetica, Geometria, ProportionietProportionalita (Everything about
Arithmetic, Geometry, Proportions and Proportionality) and it summarizes the existing mathematical knowledge at
that time. Friar Pacioli was considered the father of Double- Entry Bookkeeping.

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In the mid-18 to mid-19 centuries, the Industrial Revolution altered the way goods are produced from
the artisan/craftsman method to the assembly-line method. Cost accounting, the specialized field of accounting
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which deals with the assignment of costs to products, emerged during this period.

The corporate form of business organization was created to accommodate the need for increasingly large
amounts of funds which are required to finance the expansion of business during the period.

ACCOUNTING: LANGUAGE OF BUSINESS

ACCOUNTING DEFINED

1. Accounting Standard Council (ASC): “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.”

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National Geographic Magazine; Wikipedia.com; Image of Luca Pacioli

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 2. American Institute of Certified Public Accountants (AICPA): “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.”

3. American Accounting Association (AAA): “The process of identifying, measuring, and communicating
economic information to permit informed judgements and decisions by users of the information.”

Basically, accounting is an information system that ascertains the value of business transactions and
events; converts them into financial reports and imparts the meanings of these reports to the decision makers.

PURPOSE OF ACCOUNTING

The purpose of accounting is to help financial users see the true picture of the business in financial terms.

In helping financial users make sound economic decisions, it is therefore necessary that the financial
reports prepared by the accountants be understandable, reliable, relevant, and complete.

In a highly competitive world of business, a well-informed management is vital for the survival of a
business organization. The management must have the right information at the right time in the right way to keep
due control over its business affairs and to effect economic decisions with minimal uncertainty.

OBJECTIVES OF ACCOUNTING

1. To ascertain the result of the business operations;

2. To ascertain the financial position of the business; and
3. To assist financial users in predicting the enterprise’s financial capacity regarding future cash flows,
financial conditions and results of operation.

USERS OF ACCOUNTING INFORMATION

USERS OF ACCOUNTING INFORMATION

INTERNAL USERS EXTERNAL USERS

MANAGEMENT GROUP FINANCING GROUP PUBLIC GROUPS

Sole proprietors Investors Government

Partners Potential Investors Regulatory Agencies
Board of Directors Trade Creditors Taxing Authorities
Officers Potential Creditors Labor Unions
Managers Banks and other Employees
Supervisors financing institutions Retirees
Economic Planners
Customers

Internal Financial Reports External Financial Reports

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FORMS OF BUSINESS ORGANIZATIONS

1. Single or Sole Proprietorship

A business owned by one individual only. It is the most basic form of business organization. It is
the easiest for of business to organize since there are only minimal requirements to follow. It is less
complicated to operate and decisions are made faster since only one owner decides and all profits will go
to one owner only.

2. Partnership

An association of two or more people who bind themselves to contribute money, property, or
industry to a common fund, with the intention of dividing the profits among themselves. Partnerships are
governed by the Civil Code of the Philippines. A partnership is easier to organize than a corporation.
Better decisions are made since there are two or more owners. It is also less complicated to operate than
a corporation.

3. Corporation

An artificial being created by operation of law, having the right of succession and the powers and
attributes expressly authorized by law or incident to its existence. Corporation is the most complex for of
business organization. The owners of a corporation are shareholders. Certificates of stocks are issued to
evidence ownership in a stock corporation.

TYPES OF BUSINESS OPERATIONS

1. Service business

This is the simplest form of business. This business renders services to customers or clients in
exchange for a fee. Examples are operators of public transport, beauty parlors, security agencies,
janitorial services and professionals who practice their professions like doctors, nurses, accountants,
lawyers, and engineers.

2. Merchandising business

This business buys goods or commodities from suppliers and sellsthe same at a profit. Examples
are sari-sari stores, groceries, supermarkets, hardwares, drug stores, car dealers, real estate dealers and
appliance stores.

3. Manufacturing business

This business is quite similar to a merchandising business in that both sell the goods at a profit.
The difference is that a manufacturing business actually produces the goods that it sells to its customers.

SPECIALIZED ACCOUNTING FIELDS

1. Public Accounting

Accountants and their staff who offer services on a fee basis are said to be engaged in public
accounting. In public accounting, an accountant may practice as an individual or as a member of a public

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 accounting firm. Certified Public Accountants (CPAs) are public accountants who have met the required
education, experience and examination requirements for obtaining a CPA certificate.

Services offered by CPAs in public practice are:

a. Auditing
b. Tax services
c. Management advisory services or management consulting

2. Private Accounting

Accountants employed by a business firm or not-for-profit organization are said to be engaged in

private accounting. They may be called controller or the chief accountant in a business. They may also be
employed as vice-presidents for finance, cost accountant, internal auditors or even budget director.

3. Accounting Education

Accountants employed as instructors, professors, reviewers or researchers are in the field of

accounting education. Only Certified Public Accountants can engage in this field of endeavour.

4. Government

Accountants employed in any governmental units are said to be in the field of government
accounting. They may be hired or employed as auditor, budget officer or even consultant in government
units like the Securities and Exchange Commission, the Bureau of Internal Revenue, the Bureau of
Customs, the Department of Finance or the Department of Budget and Management.

BASIC FINANCIAL STATEMENTS

Financial Statements are the formal reports prepared by accountants. These statements show the
financial effects of transactions and other events by grouping them into broad classes according to their economic
characteristics. These broad classes are termed elements of financial statements.

1. Statement of Financial Position (SFP) formerly known as the Balance Sheet. This shows the financial
position of the business entity at any given time. The elements of the financial position are Assets,
Liabilities, and Owner’s Equity.

2. Income Statement. This shows the operating performanceof the business entity for a given period. The
elements of performance are Revenue, and Expenses.

3. Statement of Changes in Equity. This financial report shows the movements in the various elements of
the owner’s capital for a certain period.

4. Cash Flow Statement. This financial report explains the changes of cash and cash equivalents during an
accounting period.

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ELEMENTS OF FINANCIAL STATEMENTS

Statement of financial position

An asset is a resource controlled by the enterprise as a result of past events and

ASSETS from which future economic benefits are expected to flow to the enterprise.

Any medium of exchange that the bank will accept at face value. It includes coins
 Cash and currencies, checks, money orders, bank drafts, and bank deposits.

These are claims against debtors or customers arising from the provision of
 Accounts services or delivery of goods on credit.
Receivable
These are claims against debtors or customers evidenced by a written promise to
pay called a promissory note.
 Notes Receivable
Assets held for sale in the ordinary course of business, in the process of
 Inventories production for sale, or in the form of materials or supplies to be consumed in the
production process or in the rendering of services.

These are expenses paid for by the business in advance.

Tangible assets held by a business for use in production of goods or services of

 Prepaid Expenses goods or services, or for rental to others, or for administrative purposes and which
are expected to be used during more than one accounting period. Examples are:
 Property, Plant and Land, Building, Equipment, Automobile, Truck etc.
Equipment
A liability is a present obligation of the enterprise arising from past events, the
LIABILITIES settlement of which is expected to result in an outflow from the enterprise of
resources embodying economic benefits.

 Accounts Payable These are amounts due to creditors arising from the purchase of merchandise or
services on account.
 Notes Payable
These are amounts due to creditors evidenced by a written promise to pay.

Amounts owned to others for unpaid expenses. Examples are Salaries Payable,
 Accrued Liabilities Utilities Payable, Interest Payable and Taxes Payable.

Revenues collected in advance.

 Unearned
Revenues
These are long-term debts secured by certain assets as collateral.
 Mortgage Payable
This is the residual interest in the assets of the enterprise after deducting all its
OWNER’S EQUITY liabilities.

 Capital This is used to record the initial or original investments of the owner.

Another term is “Drawing” or “Personal”. This is used to record any withdrawal of

cash or other assets of the business by the owner intended for any personal or
 Withdrawal non-business use.

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 Income statement

Refers to the increase in economic benefits during the accounting period in the
form of inflows or enhancements of assets or decreases of liabilities that result
INCOME in increase in equity, other than those relating to contributions from equity
participants. It encompasses revenue and gains.

 Service Income, Fees These are revenues earned by rendering services to customers or clients.
Income
These are revenues earned by selling merchandise to customers.
 Sales

Refers to decreases in economic benefits during the accounting period in the

form of outflows or depletion of assets or increases of liabilities that result in
EXPENSES decrease in equity, other than those relating to distributions to equity
participants.

 Cost of sales Value of merchandise sold.

 Rent Expense This is used to record expenses for leased office spaces, building or other
assets.

 Supplies Expense Records the supplies used by the business.

 Depreciation Records the portion of the cost of a tangible asset like building allocated as
Expense expense during an accounting period.

 Interest Expense Used to record an expense for using borrowed funds.

 Uncollectible Used to record the amount of receivables estimated to be uncollectible and

Accounts Expense charged to expense during an accounting period. Also called as Provision for
Doubtful Accounts, Bad Debts Expense or Doubtful Accounts Expense.

Interrelationship of financial statements

 Profits/losses must be computed first, so the income statement is prepared first.

 The statement of changes in financial position depends on the results of income statement and statement of
changes in equity.
 The ending cash figure in the statement of cash flows is reported in the statement of financial position.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

The authoritative body of accountancy formulated standard principles, assumptions, and procedures
called “Generally Accepted Accounting Principles (GAAP).” These principles guide accountants in measuring,
recording, and reporting financial activities of an enterprise. These are developed based on experience, research
and careful study. They become generally accepted by agreement among accounting practitioners.

The main objective of GAAP is expressed in the phrase of the standard auditor’s report which states “to
fairly present the financial statements… in conformity with generally accepted accounting principles.”

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BASIC ACCOUNTING CONCEPTS OR ASSUMPTIONS

BASIC ACCOUNTING ASSUMPTIONS

UNDERLYING IMPLICIT ASSUMPTIONS

ASSUMPTIONS

Accrual Basis Accounting Entity

Going Concern Monetary unit

Time Periods