Intermediate Accounting 1

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Overview of Accounting

Module 001: Overview of Accounting

Course Learning Outcomes:

1. Define accounting and understand its basic purpose.
2. Understand the basic concepts applied in accounting.
3. Know the branches of accounting and sectors in the practice of
accountancy.
4. Understand the need for financial reporting standards and how they are
developed.
5. Appreciate the reason for the adoption of International Financial
Reporting Standards.

Definition of Accounting
According to the American Association of Accountants (AAA), accounting is the process of
identifying, measuring, and communicating economic information to permit informed
judgment and decisions by users of information.
There are three important activities in the definition of accounting. They are identifying,
measuring and communicating.

Identifying
Identifying is the process of analyzing events and transactions to determine whether
they will be recognized in the books or not.
Only accountable events are recognized in the books. An accountable event is an
event that has an effect on the assets, liabilities and equity of an entity and its effect
can be measured reliably. This is also known as economic activity. Only economic
events are recognized in accounting. Sociological and psychological matters are not
recognized.
Non-accountable events are not recognized. However, they are nonetheless disclosed
in the notes when such events have accounting relevance.
Recognition refers to the process of including the effects of an accountable event in
the statement of financial position (balance sheet) or the statement of profit or loss
(income statement) and other comprehensive income through a journal entry in the
books. The disclosure only of non-accountable events in the notes to financial
statements is not an application of thee recognition process. A non-accountable event
that has an accounting relevance may be recorded through a memorandum entry.

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 Types of Events or Transactions
1. External events – events which involve an entity and an external party.

Types of External Events

1) Exchange (reciprocal transfer) – an event wherein there is a reciprocal
giving and receiving of economic resources and/or economic
obligations between an entity and an external party.

Examples: sale, purchase, payment of liabilities, and receipt of note

receivable in exchange for an account receivable.

2) Non-reciprocal transfer – an event in which an entity transfers (or

receives) economic resources to (from) another entity without directly
receiving (or giving) value in exchange. A non-reciprocal transfer is a
one-way transaction. The party giving something under non-reciprocal
transfer does not receive anything in return, and the party receiving
does not give anything in exchange.

Examples: provision of capital by owners, distributions to owners,

payment of taxes, gifts and charitable contributions, donation of assets,
imposition of fines, thefts, etc.

3) External event other than transfer – an event that involves changes in

the economic resources or obligations of an entity caused by an
external party or external source but does not involve transfers of
resources or obligations.

Examples: vandalism, obsolescence, changes in fair values, price level

changes, and technological changes.

2. Internal events – events which do not involve an external party.

Types of Internal Events

1) Production – the process by which resources are transformed into
finished goods.

Examples: transformation of raw materials into finished products,

growth, procreation, and degeneration of biological assets.

2) Casualty – an unanticipated loss from disasters or other similar events.

Examples: loss from fire, flood, earthquake and other catastrophes.

Measuring
Measuring is the assigning of numbers (normally in monetary terms) to the economic
transactions and events.

Communicating
Communicating is the process of transforming economic data into useful accounting
information, such as financial statements and other accounting reports, for
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Overview of Accounting

dissemination to users. It also involves interpreting the significance of the processed

information.
The following are three aspects in the communication process of accounting:
1. Recording – refers to the process of systematically committing into writing
the identified and measured accountable events in the journal through journal
entries.

2. Classifying – involves the grouping of similar and interrelated items into their
respective classes through posting to the ledger.

3. Summarizing – putting together or expressing in condensed form the

recorded and classified transactions and events. This includes the preparation
of financial statements and other accounting reports.
Interpreting the processed information involves the computation of financial
statement ratios. Some regulatory bodies (like Bangko Sentral ng Pilipinas) require
certain financial ratios to be disclosed in the notes to financial statements.

Basic Purpose of Accounting

The basic purpose of accounting is to provide quantitative information, primarily financial
in nature, about economic entities that is intended to be useful in making economic
decisions.

Types of Accounting Information

1. Quantitative information – refers to information expressed in numbers,
quantities or units.

2. Qualitative information – refers to information expressed in words or

descriptive form. This information is found in the notes to financial statements
and on the face of other financial statements.

3. Financial information – information expressed in money. This is also

quantitative information because money is normally expressed in numbers.
Accounting information should be stated in a common denominator to be useful. For
example, amounts in foreign currencies should be translated into pesos.

Types of Accounting Information as to Users’ Needs

1. General purpose accounting information – refers to information designed to
meet the needs of most statement users. This is provided under financial
accounting and governed by Generally Accepted Accounting Principles (GAAP)
represented by the Philippine Financial Reporting Standards (PFRSs)

2. Special purpose accounting information – refers to information designed to meet

the specific needs of particular statement users. This is provided by types of

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 accounting other than financial accounting such as management/managerial
accounting and tax basis accounting.

Sources of Information in Financial Statements

Information in financial statements is not obtained solely form the accounting
records of an entity. Some information in financial statements are obtained from
external sources.
Examples of information from external sources are as follows:
1. Fair value measurement and related disclosures
2. Resolutions of uncertainties of losses on pending law suits and similar
provisions
3. Information on contingent liabilities
4. Note disclosures of future lease payments, commitments, risk management
policies, and capital management.

Accounting Concepts
Accounting concepts are principles on which the accounting process is based. Most
accounting concepts are derived from the Conceptual Framework and the Philippine
Financial Reporting Standards (PFRSs). However, some accounting concepts are implicit
meaning they are not expressly stated in the framework or PFRSs but are generally
accepted because of their long-time use in the profession.

Examples of Accounting Concepts

1. Double-entry system – each accountable event is recorded in two parts – debit
and credit. Debit means left side while credit means right side.

2. Going concern assumption – the entity is assumed to carry on its operations for
an indefinite period of time. The entity does not expect to end its operations in
the foreseeable future.

3. Separate entity (Accounting entity/Business entity concept/Entity concept) –

the entity is viewed separately from its owners. Accordingly, the personal
transactions of the owners among themselves or with other entities are not
recorded in the entity’s accounting records.

4. Stable monetary unit (Monetary unit assumption) – assets, liabilities, equity,

income and expenses are stated in terms of a common unit of measure (peso in
the Philippines). The purchasing power of the peso is regarded as stable or
constant and that instability is insignificant and ignored.

5. Time period (Periodicity/Accounting period) – the life of the entity is divided

into series of reporting periods. An accounting period is usually 12 months and
may either be a calendar year or a fiscal year period.
 Calendar year period – starts on January 1 and ends on December 31 of
that same year.
 Fiscal year period – also covers 12 months but starts on a date other than
January 1.
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Overview of Accounting

6. Materiality concept – information is material if its omission or misstatement

could influence economic decisions. Materiality is a matter of professional
judgment and is based on the size and nature of an item being judged.

7. Cost-benefit (Cost constraint/Reasonable assurance) – the cost of processing

and communicating information should not exceed the benefits to be derived
from it.

8. Accrual basis of accounting – income is recognized when earned rather than

when cash is collected and expenses are recognized when incurred rather than
when cash is paid.

9. Historical cost concept (Cost principle) – the value of an asset is determined on

the basis of acquisition cost. This is not always maintained. Some PFRSs require
the departure from this concept, such as when inventories are measured are
measured at net realizable value (NRV) rather than at a cost when applying the
“lower of cost and NRV” measurement.

10. Concept of articulation – all of the components of a complete set of financial

statements are interrelated.

A complete set of financial statements consists of the following:

1) Statement of financial position/balance sheet
2) Statement of profit or loss and other comprehensive income
3) Statement of changes in equity
4) Statement of cash flows
5) Notes to financial statements
6) Additional statement of financial position (required only when certain
instances occur)

11. Full disclosure principle – this principle recognizes that the nature and amount
of information included in the financial statements reflect a series of judgmental
trade-offs. The trade-offs strive for:
 sufficient detail to disclose matters that make a difference to users, yet
 sufficient condensation to make the information understandable, keeping
in mind the costs of preparing and using it.

12. Consistency concept – the financial statements are prepared on the basis of
accounting principles that are applied consistently from one period to the next
period/s.

13. Matching (Association of cause and effect) – costs are recognized as expenses
when the related revenue is recognized.

14. Entity theory – the accounting objective is geared towards proper income
determination. Proper matching of costs against revenues is the ultimate end.
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 This theory emphasizes the income statement and is exemplified by the unifying
equation “Assets = Liabilities + Capital.”

15. Proprietary theory – the accounting objective is geared towards the proper
valuation of assets. This theory emphasizes the importance of the balance sheet
and is exemplified by the unifying equation “Assets = Liabilities + Capital.”

16. Residual equity theory – this theory is applicable when there are two classes of
shares issued (ordinary and preferred). The equation is “Assets – Liabilities –
Preferred Shareholders’ Equity = Ordinary Shareholders’ Equity.”

17. Fund theory – the accounting objective is the custody and administration of
funds. The objective is directed towards cash flows, exemplified by the formula
“cash inflows – cash outflows = fund.”

18. Realization – the process of converting non-cash assets into cash or claims for
cash. It is also the concept that deals with revenue recognition.

19. Prudence (Conservatism) – refers to the use of caution when making estimates
under conditions of uncertainty, such that assets or income are not overstated
and liabilities or expenses are not understated.

Common Branches of Accounting

1. Financial accounting – is the branch of accounting that focuses on general purpose
financial statements. General purpose financial statements are those statements that
cater to the common needs of a wide range of external users. External users are those
who do not have the authority to demand financial reports tailored to their specific
needs. This accounting is governed by the Philippine Financial Reporting Standards
(PFRSs).

2. Management accounting – is the accumulation and communication of information for

use by internal users or management.

3. Cost accounting – is the systematic recording and analysis of the costs of materials,
labor, and factory overhead incident to production.

4. Auditing – is the process of evaluating the correspondence of certain assertions with

established criteria and expressing an opinion thereon.

5. Tax accounting – is the preparation of tax returns and rendering of tax advice, such as
the determination of the tax consequences of certain proposed business endeavors.

6. Government accounting – is the accounting for the government and its

instrumentalities, placing emphasis on the custody of public funds, the purposes for
which those funds are committed, and the responsibility and accountability of the
individuals entrusted with those funds.

7. Fiduciary Accounting – is the handling of accounts managed by a person entrusted

with the custody and management of property for the benefit of another.
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8. Estate accounting – is the handling of accounts for fiduciaries who wind up the affairs
of a deceased person.

9. Social accounting (social and environmental accounting or social responsibility

reporting) – is the process of communicating the social and environmental effects of an
entity’s economic actions to the society.

10. Institutional accounting – is the accounting for non-profit institutions other than the
government.

11. Accounting systems – the installation of accounting procedures for the accumulation
of financial data and designing of accounting forms to be used in data gathering.

12. Accounting research – is the careful analysis of economic events and other variables to
understand their impact on decisions.

Four Sectors in the Practice of Accountancy

Under R.A. 9298 or the “Philippine Accountancy Act of 2004”, accounting practice is sub-
classified into the following:
1. Practice of Public Accountancy – involves the rendering of audit or accounting-
related services to more than one client on a fee basis.

2. Practice in Commerce and Industry – refers to employment in the private sector in a

position which involves decision making requiring professional knowledge in the
science of accounting and such position requires that the holder thereof must be a
certified public accountant.

3. Practice in Education/Academe – employment in an educational institution which

involves teaching of accounting, auditing, management advisory services, finance,
business law, taxation, and other related subjects.

4. Practice in the Government – employment or appointment to a position in an

accounting professional group in the government or in a government-owned and/or
controlled corporation, including those performing proprietary functions, where
decision making requires professional knowledge in the science of accounting, or where
civil service eligibility as a certified public accountant is a prerequisite.

Accounting Standards
The Philippine Financial Reporting Standards (PFRSs) represent the generally accepted
accounting principles (GAAP) in the Philippines. They are adopted by the Financial
Reporting Standards Council (FRSC) and comprise Philippine Financial Reporting
Standards (PFRSs), Philippine Accounting Standards (PASs), and Interpretations.

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The Need for Reporting Standards
Financial statements should be prepared using reporting standards that are
generally acceptable for them to be useful. The term “generally acceptable” means
that either the standards has been established by an authoritative accounting rule-
making body or the principle has gained general acceptance due to practice over
time and has been proven to be most useful. Entities should follow a uniform set of
reporting standards when preparing and presenting financial statements.

Hierarchy of Reporting Standards

Entities consider the following in descending order when selecting its accounting
policies:
1. Philippine Financial Reporting Standards (PFRSs)
2. In the absence of a PFRS, management shall use its judgment in developing
and applying an accounting policy that results in relevant and reliable
information.

In making the judgment,

1) Management shall refer to, and consider the applicability of, the
following sources in descending order:
a. The requirements in PFRSs dealing with similar and related
issues
b. The Conceptual Framework
2) Management may also consider the following:
a. Pronouncements of other standard-setting bodies
b. Accounting literature and accepted industry practices
(PAS 8.7 - .12)

Accounting Standard Setting Bodies and Other Relevant Organizations

1. Financial Reporting Standards Council (FRSC) – is the official accounting
standard setting body in the Philippines created under the Philippine
Accountancy Act of 2004 (R.A. No. 9298).

The FRSC is composed of 15 persons – a chairperson who had been or presently

a senior accounting practitioner in any accounting practice and 14 representative
members.

2. Philippine Interpretations Committee (PIC) – is a committee formed by the

Accounting Standards Council (ASC), the predecessor of FRSC, with the role of
reviewing the interpretations of the International Financial Reporting
Interpretations Committee (IFRIC) for approval and adoption by the FRSC.

3. Board of Accountancy (BOA) – is the professional regulatory board created

under R.A. No. 9298 to supervise the registration, licensure and practice of
accountancy in the Philippines. The Board of Accountancy consists of a
chairperson and 6 members appointed by the President of the Philippines. The
Board shall elect a vice-chairperson from among its members for a term of 1
year.
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4. Securities and Exchange Commission (SEC) – is the government agency

tasked in regulating corporations and partnerships, capital and investment
markets, and the investing public. Some SEC Rulings affect the accounting
requirements of entities and the adoption and application of accounting policies.

5. Bureau of Internal Revenue – administers the provisions of the National

Internal Revenue Code (NIRC). These provisions do not always reflect the goals
of financial reporting. However, they do at times influence the choice of
accounting methods and procedures.

6. Bangko Sentral ng Pilipinas (BSP) – influences the selection and application of

accounting policies by banks and other entities performing banking functions.

7. Cooperative Development Authority (CDA) – influences the selection and

application of accounting policies by cooperatives.

International Accounting Standards

The International Accounting Standards Board (IASB) is the standard-setting
body of the IFRS Foundation with the main objectives of developing and promoting
global accounting standards.
The standards issued by the IASB are the International Financial Reporting
Standards (IFRSs), composed of the International Financial Reporting Standards
(IFRSs), International Accounting Standards (IASs) and Interpretations.
The IFRSs are standards issued by the IASB after it replaced its predecessor, the
International Accounting Standards Council. The IASs are standards issued by the
IASC which were adopted by the IASB. The PFRSs and the PASs are based on these
standards.

Other Relevant International Organizations

1. International Financial Reporting Interpretations Committee (IFRIC) – is a
committee that prepares interpretations of how specific issues should be
accounted for under the application of IFRS where the standards do not include
specific authoritative guidance and there is a risk of divergent and unacceptable
accounting practices.

2. IFRS Advisory Council (previously known as the Standards Advisory Council) –

is a group of organizations and individuals with an interest in international
financial reporting. The IFRS Advisory Council’s role includes advising on
priorities within the IASB’s work program. The IASB is required to consult with
the Advisory Council in advance of any board decisions on major projects that it
wishes to add to its agenda.

3. International Federation of Accountants (IFAC) – is a non-profit, non-

governmental, non-political organization of accountancy bodies that represents

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 the worldwide accountancy profession. Its mission is to develop and enhance the
profession to provide services of consistently high quality in the public interest.

4. International Organization of Securities Commissions (IOSCO) – is an

international body of security commissions. One of its members is the Philippine
SEC.

Changes in Reporting Standards

Once established, financial reporting standards are continually reviewed, revised or
superseded. Changes to reporting standards are primarily made in response to users’
needs. Users’ needs for financial information change so financial reporting standards
must change in order to continually provide useful information. Legal, political,
business and social environments also influence changes in reporting standards.
Regulatory bodies, lobbyists, laws and regulations, and changes in economic
environment affect the choice of accounting treatment provided under the reporting
standards.

References and Supplementary Materials

Books and Journals
1. Valix, C.T., Peralta, J.F, & Valix, C.M. (2019), Intermediate Financial Accounting (2019
edition, Volume 1). Manila, Philippines: GIC Enterprises & Co., Inc.
2. Robles, N.S., & Empleo, P.M., The Intermediate Accounting Series Volume 1 (2016
edition). Manila, Philippines: GIC Enterprises & Co., Inc.
3. Milan, Z.V.B., Intermediate Financial Accounting 1A (2016 edition). Baguio City,
Philippines: Bandolin Enterprise

Online Supplementary Reading Materials

1. https://www.ifrs.org/use-around-the-world/use-of-ifrs-standards-by-
jurisdiction/philippines/; August 9, 2019
2. http://philcpa.org/accounting-auditing-standards/accounting/pfrs/; August 9, 2019