M1: FINANCIAL ACCOUNTING FOR IE Instructor: JOSIE B.

AGUILA, MPMBA

I. Brief History of Accounting

A. Primitive

The origin can be traced back to 8500 B.C. account records date back to the ancient civilizations of China, Babylonia,
Greece and Egypt. At around 3600 B.C. in Babylonia, clay tablets recorded the payments of wages.

The rulers of these civilizations used accounting to keep track of costs of labor and materials used in building structures
as in the case of Pharaohs of Egypt in building their great pyramids.

B. Middle Ages

During the 14th to 15th centuries, merchants and bankers in Florence, Venice and Genoa developed a formal account
keeping method.

In Genoa in 1340 a.d., the double entry records first appeared. Double entry bookkeeping is not a discovery of science; it is
the outcome of continued efforts to meet the changing necessities of trade.

In 1494 Venice, Fra Luca Pacioli, one of the most celebrated mathematics of his day, wrote the first treatise on the art
of systematic bookkeeping entitled ‘everything about arithmetic, geometry, proportions and proportionality’

C. Industrial Revolution and Corporate Organization

In England, the industrial revolution started from the mid-18th and mid-19th century that changed the method of producing
commercial goods from the handicraft method to the factory system. With this change came the problem of costing large volume of
products. The specialized field of cost accounting emerged.

The industrial revolution resulted in the development of the corporate form of organization

D. Information age

The advent of ‘internet’ along with e-commerce brought a huge change in the field of accounting from manual to
automation.

Tasks that are time consuming when done manually can now be done with speed, consistency, precision and reliability of
computers.

Introduction of cloud based accounting software.

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II. Accounting: the Language of Business

A. Definition and Importance of Accounting in a Business Enterprise

1. “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 decision.” - Accounting Standard Council (ASC)

2. “Accounting is 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.” - American Institute of
Certified Public Accountants (AICPA)

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

The objective of accounting is to provide information to statement users so that they could make informed judgments and
better decision.

B. Users of Financial Statements

1. Owners – interested for returned of profits

2. Investors – interested in the risk and return of investments
3. Creditors/Suppliers – for information of collectability of their claims
4. Lenders/Banks – interested whether their loans and interest will be paid
5. Customers – for information of sustained supply for their purchases
6. Employees – for benefits and remuneration
7. Government – taxes and regulations
8. Public – general welfare

C. Business Organizations and Operations

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 form 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 form 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 sells the 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.

III. 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. Statement of Comprehensive Income or the Income Statement.

This shows the financial performance or operating performance of the business entity for a given time period.
The elements of performance are revenue, expenses and profit or loss of an entity.

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.

Elements of Financial Statements

Quantitative information reported in the Financial Statements.

1. Assets
Resources controlled by the entity as a result of past events and which future economic benefits are expected to flow to
the entity

2. Liabilities
Present obligations arising from past events the settlement of which is expected to result in an outflow of resources
embodying economic benefits

3. Equity
Residual interest in assets after deducting liabilities

4. Income
Increase in economic benefit during the accounting period in the form of inflow or increase in asset or decrease in
liability that result to increase in equity, other than contributions from equity participants

5. Expense
 Decrease in economic benefit during the accounting period in the form of outflow or decrease in asset or increase in
liability that result to decrease in equity, other than distribution from equity participants

Recognition of Elements
Means reporting of an asset, liability, income, expense or equity in the FS.

Recognition Principles
1. Asset Recognition Principle
– Recognized asset when
a. Probable that economic benefits will flow in the future
b. Can be measured reliably
- Cost principle is inherent in this recognition, which is to recognize assets at historical cost

2. Liability Recognition Principle

- Recognized liability when
a. Probable that an outflow of economic benefits will be required in the future
b. Can be measured reliably

3. Income Recognition Principle

- Income recognition principle states that income is recognized when ‘earned’ regardless of receipt.

4. Expense Recognition Principle

- States that expense is recognized when ‘incurred’ regardless of payment.
- This is the result of the application of the matching principle

Matching Principle
– Generation of revenue is not without any cost ‘ no pain no gain’. This requires that cost and expenses incurred
in earning revenue shall be reported in the same period.

Application of Elements

1. Cause and Effect Association

- Expense is recognized when the revenue is already recognized e.g. cost of sales

2. Systematic and Rational Allocation

– some costs are expensed by simply allocating them over the periods benefited e.g. depreciation

3. Immediate Recognition
– Cost is expense outright because of the uncertainty of future economic benefits e.g. loss on fire, admin and selling
expenses, loss from disposal

Measurement of Element
1. Historical Cost
– Purchase price paid at the time of acquisition (past)
2. Current Cost
– Purchase price today (present)
3. Realizable Value
– If an asset will be disposed today, the amount of cash that will be received (present)
4. Present Value
– Discounted value of future net cash inflows - future exchange price (future)

IV. Generally Accepted Accounting Principles (GAAP)

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. Also, GAAP encompass the conventions, rules, and procedures necessary to define
what is accepted accounting practice.

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.”
 International Accounting Standards Committee (IASC) – based in London, UK that set the standards called
International Financial Reporting Standards (IFRS) replaced International Accounting Standards Board (IASB)

Composition of IFRS
a. International accounting standards (IAS)issued by IASB
b. International Financial Reporting Standards issued by IASC
c. Interpretations

What are Accounting Standards?

Accounting Standards are authoritative statements of how particular types of transactions and other events should be
reflected in the financial statements.

Note: in the Philippines, Financial Reporting Standards Council (FRSC) developed the GAAP that will be promulgated in the
country. Approved standard are known as Philippine Financial Reporting Standards (PFRS)

Accounting Assumptions
- Basic notions or fundamental premises on which the accounting process is based. Also known as postulates
-This serves as the solid foundation and building block to avoid misunderstanding, but rather enhance
understanding and usefulness

Objectivity
- An accounting transaction should be supported by sufficient evidence to allow two or more qualified
individuals to arrive at essentially similar conclusion.

Underlying Assumptions Going

Concern Assumption
- That the business will continue for an indefinite period of time

Implicit in the going concern assumption

a. Entity Concept
– Owners and business are separate and distinct economic unit
b. Periodicity/Time Period
– Entity’s life can be subdivided into equal time periods for reporting purpose
c. Stable Monetary Unit Concept
– Philippine peso is a reasonable unit of measure and that purchasing power of money is stable

Conceptual Framework
- It is a summary of the terms and concepts that underlie the preparation of the financial statements (FS)
- An attempt to provide an overall theoretical foundation for accounting, which will guide accountants in
preparing FS.

Authority
-In case of conflict with IFRS and conceptual framework, IFRS prevails.

Scope
a. Objective of financial reporting
b. Qualitative characteristics of useful financial information
c. Definition, recognition and measurement of the elements
d. Concepts of capital and capital maintenance

a. Objective
- to provide information to statement users so that they could make informed judgment and better decision

b. Qualitative characteristics
-Attributes/Qualities that make financial accounting information useful to the users

Fundamental Qualitative Characteristics

1. Relevance
– Capacity of the information to influence a decision
2. Faithful Representation
– The information must reflect what really existed

Ingredients of Relevance
a. Confirmatory Value
 – Confirm/correct past decisions or expectation
b. Predictive Value
– Used to make predictions
c. Materiality
– Information is material if its omission or misstatement could ‘influence’ the decision of the users

Ingredients of Faithful Representation

a. Completeness
– Information that should have been recorded or disclose have been recorded and disclosed. this is the
result of principle of adequate disclosure standard
b. Neutrality
– Free from bias and does not favour any party
c. Free from Error
– no material errors or omissions

Substance Over Form

- Inherent in the term faithful representation
- Transactions are accounted for in accordance with their substance rather than the legal form

Conservatism or Prudence
-Not included as ingredient of faithful representation due to conflict with ‘neutrality’ though worth
discussing
-Caution in the exercise of judgment need in making estimates.
-To anticipate no profits and to provide for all probable and estimable losses.
-"Don’t count your chicks until the eggs hatch"

Enhancing Qualitative Characteristics

- These relates to the presentation and form of the financial information

1. Comparability
- Users must be able to compare the financial statements through time in order to identify trends in its
financial position and financial performance

2. Understandability
- FS is that it is readily understandable by users. Users are assumed to have a ‘reasonable
knowledge’ of accounting

3. Verifiability
– Information can be verified by independent observers and could reach consensus not necessarily
complete agreement

4. Timeliness
– Financial information must be available or communicated early enough when a decision is to be made