MODULE 1 OBJECTIVES

Module 1: Introduction to Accounting

Objectives:
1. Define accounting and explain its role in business.
2. Distinguish the different types and forms of business
organization as well as their characteristics.
3. Explain the different accounting concepts and elements.
4. Discuss accounting equation and its significance
5. Enumerate the accounting process.
6. Analyze a business transaction and its effect on the accounting
elements.
Topics:
Lesson 1: Definition of Accounting
Lesson 2: Accounting concepts
Lesson 3: Accounting equation
Lesson 4: Analysis of business transactions

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LESSON 1 DEFINITION OF ACCOUNTING

What is Accounting?

In the PAST, accounting is defined as

“the ART of recording, classifying, and

summarizing in a significant manner and in
terms of money, transactions and events
which are in part a least of a financial
character and interpreting the results
thereof.”

When accounting was introduced in the Philippines, the American Institute of Certified
Public Accountants (AICPA) described accounting as an “art” because it involves
creative judgement in performing the accounting functions. In accounting, there are
different ways or methods you can use but all of which will arrive at the same result.
Although accounting involves rules and processes, it is not an exact science since these
rules and processes are constantly changing due to innovations in economic
operations. The AICPA definition also enumerates the processes involved in the
performance of the accounting functions like recording, classifying, and summarizing
transactions which is popularly known as bookkeeping while interpreting the effects
thereof thru the preparation of reports is considered as financial accounting.
Since then, accounting have been defined in many ways. Accounting is often called
THE LANGUAGE OF BUSINESS. It is the means by which business information is
communicated to the stakeholders. Like any language, accounting has its own set of
terminology. Anyone wanting to communicate clearly in the business world, would need
to understand the components of the financial documents being presented by business
entities.

Although accounting is still considered as art, at PRESENT,

“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
decisions

To better understand accounting as a service activity, let us answer the following questions:

What is a service activity?

A service activity is an act, help or assistance. It involves performance of a work for

another. The performance or work done involves use of skills and experience in which
no physical goods are transferred. Service is intangible in nature.

What service does accounting provide?

Accounting provides information. Every decision maker needs information to resolve

any uncertainty. Information refers to data which relates to knowledge that is significant
in understanding business circumstances. Accounting information are quantitative and
measured in terms of money.

What information does accounting provide?

Accounting provides data about an economic entity or business. Accounting using

double-entry bookkeeping was formally introduced by an Italian mathematician named
Luca Pacioli, who is regarded as the father of accounting, particularly for businesses to
keep track of its operations. Economic entities will be further discussed later.

Why do we need accounting information?

At the end of the day, decisions must be made. As our senses collect information from
the things around us for the brain to interpret, gathering and processing information
about our business are important steps in decision making to arrive at a more
deliberate and rational judgements.
Information Technology (IT) professionals would define accounting as:

“an INFORMATION SYSTEM that provides reports about the economic activities
and condition of a business to interested parties.”

In IT terms, accounting provides a syntax or arrangement that allows collection, storage,

processing, retrieval and interpretation of business information needed by interested
parties.

The global computer network or “internet” will provide numerous definitions of term
accounting. An example is a definition given by 365 Careers at
https://youtu.be/ABjCVTBnO_U which states that accounting is:

“an INFORMATION SCIENCE that is used to collect and organize financial data
for organizations and individuals”

Accounting is both a science and an art. It is a science because it applies objectivity,

verifiability and reliability at the same time it is an art because it requires practice,
practical knowledge, creativity and personal skills.

BUSINESS ENTITIES

Although accounting is involved in many of the information we use in the different

aspect of our personal life, accounting was primarily developed for business use. As a
service activity, accounting provides information about ECONOMIC ENTITIES.
Accordingly, in order to effectively perform accounting services, it Is important that one
has basic knowledge about the business, its ownership structure and type of operation.

We can start by answering three basic questions as follows:

What is an economic entity?

Economic or BUSINESS ENTITY is an organization intended to carry out

commercial activity by using economic resources to provide goods or services to
satisfy the needs of its customers. A commercial activity involves an
undertaking relating to business intended to make money in the form of profits or
gains.

What are the forms of business organization?

There are four (4) basic forms of business organization which defines the
ownership structure of the business as follows:

a) Sole Proprietorship
b) Partnership
 c) Corporation
d) Cooperatives

For purposes of discussion, modules 1, 2 and 3 would involve SOLE

PROPRIETORSHIP, where a business is owned by only one person.

What are the types business operations?

Business operations vary depending on how business process is being

conducted. There are three (3) major types of business operations as follows:

a) SERVICE
b) MERCHANDISING
c) Manufacturing

For purposes of discussion, this course will not include manufacturing type of
operation.

IMPORTANCE OF ACCOUNTING

Accounting services involves processing of information gathered during its operations in

terms of quantitative or measurable data primarily financial in nature or in term on
money. These data or information are intended to be useful to the business
STAKEHOLDERS. The stakeholders are those individuals or group of individuals who
are interested in the business who are considered the users of accounting information.
Examples of business stakeholders are owners, managers, creditors, customers and
the government.

Information is prepared considering the different needs of its users as follows:

STAKEHOLDERS NEEDS
1. Owners/Investors Risks of capital
2. Management To carry out its planning, decision making
and control
3. Employees Ensure their salaries
4. Lenders / Creditors / Suppliers Possibility of receiving payments for loan
principal and interest
5. Customers Dependability in terms of continuous
relationship
6. Government Compliance with regulations
7. Public Contribution to local economy
 LESSON 2 ACCOUNTING CONCEPTS

Before we start studying the accounting process, we need to be guided by the different
accounting concepts to serve as rules in accounting for financial transactions and preparing
financial reports. Accounting concepts can be classified into three categories namely:
assumptions, restrictions, and limitations.

What are the accounting concepts?

1. ASSUMPTIONS

a) Business entity – This assumption separates the business from its owners. Under
this concept we need to identify and segregate business transactions from the
owner’s personal transactions. By maintaining separate records for the business,
the owner would have a clear perception on the performance of his business. This
concept also assures that no personal losses shall be carried in the books of the
business for the protection of its stakeholders thereby maintaining the trust and
confidence of the business industry.

b) Going concern – This concept assumes the business will continue to operate
indefinitely. This leads to an expectation by the stakeholders that the business will
not wind up its operation and would be able to meet its obligations. This concept
guarantees the business continuity with regards to its future commitments.

c) Accounting period – This concept supplements “going concern” where the firm’s
indefinite life is divided into periods normally, one year or 12 months. To be able to
know the results of operations and assess the firm’s performance, the business
would need to close its books of accounts but not necessarily stop operations. This
also enables comparison of the firm’s performance from period to period.

d) Measurement in money – Accounting provide quantitative information that are

financial in nature. Only business activities that can be expressed or measured in
monetary terms shall be recorded in the accounting books. Consequently, a
business cannot record non-quantifiable items such as quality of service and
employee skill level or expertise.

2. RESTRICTIONS

a) Materiality – this concept dictates the all significant facts must be part of the
accounting process and only insignificant data may be left out. This concept ensures
that no vital information is excluded from the financial reports for the stakeholders to
arrive at a rational decision. The concept does not provide definitive rule or specific
amount to determine material information from immaterial information. Exercise of
judgement is necessary in determining the amount of impact the transaction will have
on the business.

b) Conservatism/Prudence – This concept applies the worse-case scenario of a firm’s

financial future. Possibility of losses shall be included in the financial records, but
gains should not be recorded until it is realized. Probable liabilities or obligations of
 the firm shall be recorded upon discovery. In contrast, assets are recorded when it is
certain.

c) Objectivity – This concept states that recorded transactions should be free from
bias of the person recording it. Each transaction should be verifiable by supporting
documents. This assures the stakeholders authenticity or legitimacy of all
transactions recorded in the firm’s books of accounts.

d) Consistency – Under this concept, once a firm chooses to use a specific accounting
method, it should continue using it so that multiple period reports can be reliably
compared. This provides the stakeholders a meaningful comparison between
periodic reports. But it should be clear that this concept does not limit the firm to
change method when it is necessary and appropriate. But any changes in methods
and the corresponding effects should be disclosed to the readers of the financial
reports.

3. PRINCIPLES

a) Dual aspect concept – Every transaction to be recorded would have a two-fold

effect. This principle supports the double-entry system of accounting. This means
that each accounting transaction would affect at least two items in the business
operations.

b) Historical cost principle – This concept requires a business to initially records an

asset, liability or equity at its original acquisition cost or the cost at acquisition date.

c) Faithful representation – Under this concept, financial reports should reflect a clear
picture of the results of operation and condition of the business. All the information
that the user needs are included and presents a fair view of the organization.

d) Full disclosure – This concept requires the firm to support the financial reports with
the relevant and necessary information to understand the data included on the
financial reports. Full disclosure does not mean release of all information but rather
disclosure of information which would have a material impact on the firm’s result of
operation and financial condition. This concept foster transparency among firms in
the business industry.

e) Revenue recognition principle – This concept entails revenue to be recognized in

the financial reports at the period when they are realized and earned regardless of
collection. Realized revenue means services have been performed or goods have
been delivered.

f) Expense recognition / matching concept – Expenses related to revenue should

be recognize in the same period in which the revenue was reported. In cases where
expenses are difficult to correlate with revenue, said expenses would be recognize
when they are incurred regardless of payment.
 LESSON 3 ACCOUNTING EQUATION

The accounting equation is the mathematical representation that shows the relationship of the
three basic elements of accounting namely: assets, liabilities, and owners’ equity. The equation
is as follows:

ASSET = LIABILTIES + OWNERS EQUITY

The above mathematical equation is derived from the concept that for every property the
business owns there is a corresponding claimant. The claimants could either be the creditors or
the business owners. Assets are the firm’s resources. These are properties that the business
owns and practically control. On the other hand, liabilities are the firm’s obligations. Liabilities
are items that the business owes and represents the claims of creditors against firm’s assets.
Owners’ equity would be the amount that is left after deducting the firm’s liability from its asset.
This amount represents the owner’s claim over the business. This is because creditors would
have the first claim over the firm’s resources. Owner’s equity are considered the business
networth. A more technical or deeper definition of the three elements will be discuss in higher
accounting courses.

The accounting equation also show how much of the firm’s asset is being financed by creditors
and how much represents owner’s share. By performing an inverse operation on the equation
and still maintaining its algebraic equality, you will be able to determine the amount of liabilities
as follows:

LIABILITES = ASSET – OWNERS EQUITY

and determine how much is owners’ equity as follows:

OWNERS EQUITY = ASSET – LIABILTIES

To illustrate the above equations, let us assume Mr. A opened Akinto Barber Shop and invested
P75,000 cash. Mr. A then purchased equipment from Ms. B amounting to P25,000 on credit.
Based on the given information, Akinto Barber Shop acquired its assets from the investment
made by its owner, Mr A, and from a credit transaction with Ms. B. Liabilities will be equal to
P25,000 and owners’ equity is equal to P75,000. Total assets will be computed as follows:

ASSET = LIABILTIES + OWNERS EQUITY

ASSET = P25,000 + P75,000
ASSET = P100,000

Correspondingly, the following equation will also apply:

LIABILITES = ASSET – OWNERS EQUITY

LIABILITIES = P100,000 – P75,000
LIABILITIES = P25,000

OWNERS EQUITY = ASSET – LIABILTIES

OWNERS EQUITY = P100,000 – P25,000
OWNERS EQUITY = P75,000
The basic examples of assets and liabilities are as follows:

ASSETS Description
Cash This includes cash on hand or cash in bank
Accounts receivables These are open credit of customers normally
for short-term period
Notes receivables These are written promissory notes of
customers normally used for long-term credit
Supplies These represent supplies on hand or
supplies unused by the firm that are material
in amount
Prepaid expenses These are advance payments for goods or
services to be receive in the future.
Examples are prepaid insurance and prepaid
rent
Furniture Movable items used to furnish an office
generally for a long-term period
Equipment These are battery or electrically driven
instruments, or tools used in providing goods
or services generally for a long-term period.
LIABILITIES Description
Advances from customers Amount received from customers before
providing goods or services
Accounts payable These are open credit from vendors or
suppliers normally for short-term period
Notes payable These are written promissory notes of the
firm normally used for long-term credit
Loans payable Debt or credit acquired by the firm usually
from banks or lending institutions
Salaries payable Unpaid salaries or wages of employees
Utilities payable Unpaid power, water or communication cost
consumed by the firm

The composition of owners’ equity can be divided into four categories as follows:

OWNERS EQUITY Description

Capital • Investments made by owner
• Additions to owners’ equity
Drawing • Withdrawal s made by owner
• Deductions to owners’ equity
Revenue • Represents goods deliver and services provided.
These includes “sales” for merchandising and
manufacturing business and “service fees” for
service type of operation. Examples of service
fees are consulting fees, repair fees, tuition fees,
legal fees, and medical fees.
• Additions to owners’ equity
Expenses • These are consequences of revenues or cost
 incurred by the business in order to generate
revenues. Examples are salary expense, utilities
expense, rent expense, and advertising expense.
• Deductions to owners’ equity

LESSON 4 ANALYSIS OF BUSINESS TRANSACTIONS

The accounting concepts and the accounting equation sets the foundation for bookkeeping.
Business transactions are analyzed and recorded based in its effect to the firm’s asset,
liabilities, and owners’ equity. When we analyze a given business transactions, we answer the
following questions:

1. What is the transaction date?

The transaction date is the date at which the transaction occurred. Transactions
are recorded chronologically by date of occurrence. This enable the user of
financial information to determine account balances as of a specific date. Under
historical cost concept, the transaction date also plays an important role in
determining the monetary measurement of the transaction.

2. What accounting element was affected by the transaction?

We limit the answers to three: ASSET, LIABILITY, and OWNERS EQUITY.

3. What was the effect of the transaction on the accounting element?

The answer is would be an INCREASE or a DECREASE. Take note that this is

the effect on the element not on the account title. Recall that under owners’
equity, account titles may have different effects.

4. What is the account title of the element affected?

Identify the account title of the element affected. Under the dual aspect
concept, you need to identify at least two or more account title affected by the
transaction regardless of type of element. This means your analysis could
involved two or more account title within the same element.

It is important that specific title should be used in identifying the different

accounting elements to keep track of these elements in an organized and
consistent manner. This will provide the stakeholders a more meaningful
interpretation of financial reports.

5. How much is the effect on the account title?

Under measurement in money concept, the effect of transaction on the

account should be expressed in terms of money.
 6. Did the analysis satisfy the accounting equation?

Remember the foundation is the accounting equation, the effects when plotted in
the accounting equation should result to an algebraic equality.

We can use the columns titles below to represent our transaction analysis table:

Date Element Effect on Element Account Title Amount

Illustration 1.4.2: In 2018, Mr. A opened Akinto Barber Shop with the following transactions for
the first month of operation:

January 1 - Mr. A invested cash of P100,000 and furniture with a fair value of P80,000 to
Akinto Barber Shop.

Date Element Effect on Element Account Title Amount

Jan. 1 Asset Increase Cash 100,000
Asset Increase Furniture 80,000
Owners’
Increase Capital 180,000
Equity

Note: Using economic entity concept, analysis is made under business entity’s
point-of-view. The assets of Akinto Barber Shop increased upon receipt cash of
P100,000 and P80,000 worth of furniture. Correspondingly, owners’ equity also
increased by P180,000 which represents total investment of Mr. A in the barber
shop.

Check the accounting equation:

ASSET = LIABILTIES + OWNERS EQUITY
P100,000 + P80,000 = P0 + P180,000

January 3 - Purchased supplies amounting to P36,000 on credit

Date Element Effect on Element Account Title Amount

Jan. 3 Asset Increase Supplies 36,000
Accounts
Liability Increase 36,000
Payable

Check the accounting equation:

ASSET = LIABILTIES + OWNERS EQUITY
P36,000 = P36,000 + P0

January 5 - Rendered the Z-cut services to cash customers amounting to P20,000.

Date Element Effect on Element Account Title Amount

Jan. 5 Asset Increase Cash 20,000
Owners’ Increase Z-Cut Fees 20,000
 Equity

Note: The specific haircut service, Z-Cut, is use for a more detailed reporting of
revenues.

Check the accounting equation:

ASSET = LIABILTIES + OWNERS EQUITY
P20,000 = P0 + P20,000

January 8 - Paid 50% of the barber shop’s accounts payable

Date Element Effect on Element Account Title Amount

Jan. 8 Asset Decrease Cash 18,000
Accounts
Liability Decrease 18,000
Payable

Note: To compute the amount of payment, P36,000 x 50% = P18,000

Check the accounting equation:

ASSET = LIABILTIES + OWNERS EQUITY
(P18,000) = (P18,000) + P0

January 10 - Rendered X-Cut services to customers amounting to P50,000. Received cash of

P20,000 from said customers and the balance on account.

Date Element Effect on Element Account Title Amount

Jan. 10 Asset Increase Cash 20,000
Accounts
Asset Increase 30,000
Receivable
Owners’
Increase X-Cut Fees 50,000
Equity

Note: To compute amount of receivable, P50,000 – P20,000 = P30,000

Check the accounting equation:

ASSET = LIABILTIES + OWNERS EQUITY
P20,000 + P30,000 = P0 + P50,000

January 15 - Collected P6,000 of the barber shop’s accounts receivable

Date Element Effect on Element Account Title Amount

Jan. 15 Asset Increase Cash 6,000
Accounts
Asset Decrease 6,000
Receivable

Check the accounting equation:

ASSET = LIABILTIES + OWNERS EQUITY
P6,000 – P6,000 = P0 + P0
January 20 - Mr. A withdrew P5,000 cash for personal use

Date Element Effect on Element Account Title Amount

Jan. 20 Asset Decrease Cash 5,000
Owners
Decrease Drawing 5,000
Equity

Check the accounting equation:

ASSET = LIABILTIES + OWNERS EQUITY
(P5,000) = P0 + (P5,000)

January 25 - Paid monthly expenses as follows: rent, P4,000; salaries, P6,000; and utilities,
P2,000.

Date Element Effect on Element Account Title Amount

Jan. 25 Asset Decrease Cash 12,000
Owners’
Decrease Rent Expense 4,000
Equity
Owners’
Decrease Salary Expense 6,000
Equity
Owners’
Decrease Utility Expense 2,000
Equity

Note: The specific expense items are used for a more detailed reporting of
expenses.

Check the accounting equation:

ASSET = LIABILTIES + OWNERS EQUITY
(P12,000) = P0 + (P4,000) + (P6,000) + (P2,000)
Illustration 1.4.2

In 2018, Mr. A opened Akinto Barber Shop with the following transactions for the first month of operation:

January 1 - Mr. A invested cash of P100,000 and furniture with a fair value of P80,000 to Akinto
Barber Shop.
January 3 - Purchased supplies amounting to P36,000 on credit
January 5 - Rendered the Z-cut services to cash customers amounting to P20,000.
January 8 - Paid 50% of the barber shop’s accounts payable
January 10 - Rendered X-Cut services to customers amounting to P50,000. Received cash of P20,000
from said customers and the balance on account.
January 15 - Collected P6,000 of the barber shop’s accounts receivable
January 20 - Mr. A withdrew P5,000 cash for personal use
January 25 - Paid monthly expenses as follows: rent, P4,000; salaries, P6,000; and utilities, P2,000.

Requirement: TRANSACTION ANALYSIS TABLE

Date Element Effect on Element Account Title Amount

Jan. 1 Asset Increase Cash 100,000
Asset Increase Furniture 80,000
Owners’
Increase Capital 180,000
Equity
Jan. 3 Asset Increase Supplies 36,000
Accounts
Liability Increase 36,000
Payable
Jan. 5 Asset Increase Cash 20,000
Owners’
Increase Z-Cut Fees 20,000
Equity
Jan. 8 Asset Decrease Cash 18,000
Accounts
Liability Decrease 18,000
Payable
Jan. 10 Asset Increase Cash 20,000
Accounts
Asset Increase 30,000
Receivable
Owners’
Increase X-Cut Fees 50,000
Equity
Jan. 15 Asset Increase Cash 6,000
Accounts
Asset Decrease 6,000
Receivable
Jan. 20 Asset Decrease Cash 5,000
Owners
Decrease Drawing 5,000
Equity
Jan. 25 Asset Decrease Cash 12,000
Owners’
Decrease Rent Expense 4,000
Equity
Owners’
Decrease Salary Expense 6,000
Equity
Owners’
Decrease Utility Expense 2,000
Equity