LEARNING MODULE #1

FINANCIAL ACCOUNTING AND REPORTING

Chapter 1 – Introduction to Accounting

Learning Objectives:

1. Define Accounting
2. Describe the nature and purpose of accounting
3. Give examples of branches of accounting
4. State the function of accounting in business
5. Differentiate between external and internal users of accounting information
6. Narrate the history/origin of accounting
7. State the forms of business organization
8. State the types of business according to their activities.

Definition of Accounting
Accounting is a process of identifying, recording and communicating economic information that is
useful in making economic decisions

Essential elements of the definition of accounting

1. Identifying – the accountant analyzes each business transaction and identifies whether the
transaction is “accountable events” or “non-accountable event.” This is because only
“accountable events” are recorded in the books of accounts. “non-accountable event.” Are not
recorded in the book of accounts.
“Accountable events” (or economic events) are those that affect the assets, liabilities,
equity, income and expenses of a business.
2. Recording – the accountant recognizes (i.e., records) the “accountable events” he has identified.
This process is called “journalizing”
After journalizing, the accountant then classifies the effect of the event on the
“accounts”. This process is called “posting”
Account is the basic storage of information in accounting, e.g. cash, Land, sales, supplies
expense, etc.
3. Communicating – at the end of each accounting period, the accountant summarizes the
information processed in the accounting system in order to produce meaningful reports. This is
important because information processed in the accounting system is useless unless it is
communicated to interested users. Accounting information is communicated to interested users
through accounting reports, the most common forms of which is the financial statements.

Nature of accounting
 Accounting is a process with the basic purpose of providing information about economic
activities intended to be useful in making economic decisions.

Types of information provided by accounting

1. Quantitative information – information expressed in numbers, quantities, or units.
2. Qualitative information – information expressed in words or descriptive form. This is found in
the notes to financial statements as well as on the face of the other components of financial
statements.
3. Financial information – information expressed in money. It is also quantitative information
because monetary amounts are normally expressed in numbers.

Functions of Accounting in Business

Accounting is often referred to as a “language of business” because it is fundamental to the
communication of financial information
Accounting has the following two broad functions in a business:
1. To provide external users with information that is useful in making, among others,
investment and credit decisions; and
2. To provide internal users with information that is useful in managing the business.

Users of Accounting Information

1. Internal Users – those who are directly involved in the managing the business. Ex. Business
owners who are directly involved in managing the business, Board of Directors, and all
Managerial personnel
2. External users – those who are not directly involved in managing the business. Examples of
external users include:
a. Existing and potential investors(e.g., stockholders who are not directly involved in
managing the business
b. Lenders (e.g., banks) and Creditors (e.g., suppliers)
c. Government agencies (e.g., BIR, SEC)
d. Non-managerial employees
e. Customers
f. Public
Types of accounting information classified as to users’ needs

1. General purpose accounting information – is information designed to meet the common needs
of most statement users. It is provided by financial accounting and is prepared primarily for
external users.
2. Special purpose accounting information – is information designed to meet the specific needs of
particular statement users. It is provided by management accounting or other branches of
accounting and is prepared for internal users.

Examples of decisions and types of information needed to make those decisions.

User Example of decision to make Example of information needed

1. External User (investor)
2. External user (lender or
supplier)
3. Internal user (manager)
4. Internal user (manager)
*Existing investor: whether to
hold or sell investment in stocks.
*Potential investor: whether or
not to buy shares of stock.
*lender: whether or not to
extend a loan to a business.
*Supplier: whether or not to
extend credit to a business
*Whether or not to increase the
sale price of a product.
*How much capital is needed to
manufacture a new product?
Audited financial statements of
the business to aid in analyzing
the value of the company.
( General purpose information)
Audited financial statements of
the business to aid in analyzing
the company’s ability to pay its
debts.
( General purpose information)
Analysis of the effects of sales
volume and sales prices to
earnings. (Special purpose
information)
Budget report. (Special purpose
information)

Examples in which accounting is used in investment and credit decisions

External user of information Decision Accounting information

1. Investor *Shall I invest in this business? Is
this profitable undertaking
2. Creditor *Shall I lend money to this
business? Does this business
have the ability to pay back my
loan
The financial performance of the
business.
The ability of the business to
generate revenue and cash flows
from its operations.

Now that we have understood how accounting plays an important role in making business
decisions, let us have a brief overview on how accounting came to be.

Brief history of accounting

Accounting can be traced as far back as the prehistoric times. Since the dawn of civilization when
mankind began to engage in trade, perhaps more than 10,000 years ago, method of record keeping and
accounting have been invented.

As early as 8500 B.C., accounting has already existed. Archaeologists have found clay tokens as
old as 8500 B.C. in Mesopotamia which were usually cones, disks, spheres and pellets. These tokens
correspond to commodities like sheep, clothing or bread. They were used in the Middle West in keeping
records. After some time, the tokens were replaced by wet clay tablets. During such time, experts
concluded this to be the start of the art of writing.

Other ancient civilizations keeping account records are Babylonia (4500 B.C.), Egypt (2250 B.C.),
China and Greece.

In the middle ages (13th and 5th centuries), trade flourished in places such as Florence, Venice
and Genoa. This has brought advancement in account keeping methods. In 1211 A.D., one of the
systems in accounting was kept by a Florentine banker. However, the system was primitive as the
concept of equality for entries was absent. Double entry records first came out during 1340 A.D. in
Genoa.

In 1494, the first systematic record keeping dealing with the “double entry recording system”
was formulated by fra Luca Pacioli, a Franciscan monk and mathematician. The “double entry recording
system” was included in Pacioli’s book titled “Summa di Arithmetica Geomatria Proportioni and
Proportionista,” published on November 10, 1494 in Venice.

The concept of “double entry recording” is being used to this day. Thus, Fra Luca Pacioli is
considered as the father of modern accounting.

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 that cater to the common needs of
a wide range of external users. Financial accounting is governed by the Philippine Financial
Reporting Standards (PFRSs)

Financial statements
1. Statement of Financial position
2. Statement of profit or loss and other comprehensive income
3. Statement of changes in equity
4. Statement of cash flows
5. Notes
6. Additional statement of financial position

2. Management accounting – involves the accumulation and communication of information for use
by internal users. An offshoot of management accounting is management advisory services
 which include services to clients on matters of accounting, finance, business policies,
organization procedures, product costs, distribution, and many other phases of business
conduct and operations.

Financial Accounting Management Accounting

*Focuses on the information needs of external * Focuses on the information needs of internal
users. users.

3. Government accounting – refers to the accounting for government and its instrumentalities,
focusing attention on the custody, the purpose or purposes to which those funds are
committed, and the responsibility and accountability of the individuals entrusted with those
funds.
4. Auditing – involves the inspection of entity’s financial statements or business processes to
ascertain their correspondence with an established criteria.
5. Tax accounting – is the preparation of tax returns and rendering of tax advice, such as the
determination of tax consequences of certain proposed business endeavors.
6. Cost accounting – is the systematic recording and analysis of the costs of material, labor, and
overhead incident to the production of goods or rendering of services
7. Accounting education – refers to teaching accounting and accounting-related subjects in an
organized learning environment. It is a process of facilitating the acquisition of knowledge and
skills regarding one or more of the other branches of accounting.
8. Accounting research – pertains to the careful analysis of economic events and other variables to
understand their impact on decisions.

Summary:

Brach of Accounting Type of accounting service Users of service

provided
1. Financial General record keeping, i.e., All businesses use financial accounting
Accounting maintenance of Journals and in their record keeping. These records
Ledgers provide information that is also used in
the other branches of accounting

Preparation of general purpose Businesses prepare general purpose FS

financial statement(FS) at least annually for the use of lenders,
investors, or government regulatory
bodies.
2. Management Preparation of specially tailored Required by management to aid them
Accounting management reports. in performing their management
functions.
3. Government General record keeping and Required by the government and its
Accounting preparation of financial reports agencies
for the government and its
agencies. It also includes the
preparation of budgets and
 accountability reports.
4. Auditing Expression of opinion on the Businesses with gross annual sales or
correspondence between receipts exceeding 3,000,000 are
management assertions and required to have their financial
established criteria statements audited by an independent
*the most common form of an Certified Public Accountant (CPA).
audit opinion is the Independent
Auditors’ Report which is
attached to audited financial
statements.
5. Tax Accounting Preparation of tax returns. All businesses are required to file tax
returns.
*failure to file tax returns results
to penalty and imprisonment of
not less than 6 years but not more
than 10 years.

Providing tax advice Some taxpayers may require the

professional advice of a tax practitioner
regarding the management of taxes.
6. Cost Accounting Analyses of costs of products or Businesses use of cost accounting to
services. analyze the cost of their products or
services and the effects of those cost
in, among others, earnings and pricing
policies.
7. Accounting Teaching of accounting and Required by business students,
Education related subjects. business owners, accounting
professionals in their Continuing
Professional Development(CPD), and
other interested parties
8. Accounting Accounting research papers, Required by business owners,
Research articles and similar publications. professional organizations, and other
interested parties.