Accounting and Its Environment | 8 ‘ } INTRODUCTION Accounting has evolved, as in the case of medicine and law, in response to the social and economic needs of society. As business and society become more complex, accounting develops new concepts and techniques to meet the ever-increasing needs for financial information. Without such information, many, complex economic developments and social'programs may never have been undertaken. | In a market economy, information helps decision-makers make informed choices regarding the allocation of scarce resources under their control. When decision-makers are able to make well-informed decisions, resources are allocated in a way that better meets the needs and goals of those within the market. Accounting is relevant in all walks of life, and it is absolutely essential in the world of business. Accounting is the system that measures business activities, processes that information into reports and communicates the results to decision-makers. Accounting quantifies business communication. For this reason, accounting is called the language | of business. The task of learning accounting is very similar to the task of learning a new language; thus, the need for this book which teaches the Basics of Accounting in a very conceptua! manner. No business could operate very long without knowing how much it was earning and how much it was spending. Accounting provides the business with these information and more. So, accountants can be called tl re Without accounting, a business couldn’t function optimally; it wouldn’t know where it stands financially, whether it’s making a profit or not, and it wouldn’t know its financial situation. Also, a sound understanding of this language will bring about a better management of the financial aspects of living. Personal financial planning, education expenses,* car amortization, business loans, income taxes and investments are based on the information system that we call accounting. DEFINITIONS OF ACCOUNTING Accounting is af Its function is to provide (quantitative: information) primarilylfinancial in nature, about economic entities’ that is intended to be useful in making ‘economic decisions’ (Statement of Financial Accounting Standards No. 1, “Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises” (Manila: Accounting Standards Council, 1983), par. 1). ‘Accounting is an{lifforimationsisystem| that "measures, processes and’ communicates? financial information about an economic entity (Statement of Financial Accounting Coricepts No. 1, “Objectives of Financial Reporting by Business Enterprises” (Norwalk, Conn.: Financial ‘Accounting Standards Board, 1978), par. 9).1-4 | Basic Financial Accounting and Reporting 2022 Edition by Prof. WIN Ballada Accounting is thef/process! of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information (American Accounting Association, “A Statement of Basic Accounting Theory” (Evanston, IIL American Accounting Association, 1966), par. 1; Accounting Principles Board, Statement No. 4, “Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises” (New York: AICPA, 1970), par. 40). Accounting is thelartJof recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof (American Institute of Certified Public Accountants, “Review and Resume”, Accounting Terminology Bulletin No. 1 (New York: AICPA, 1953), par. 9). EVOLUTION OF ACCOUNTING Accounting history is important to accounting pedagogy, policy and practice. It makes it possible to better understand our present and to forecast our future. eAccounting (history is the “study of the evolution in accounting thought, practices and institutions in response to changes in the environment and societal needs. It also considers the effect that this evolution has worked on the environment.’” Primitive Accounting People have counted and kept records throughout history. The origin of keeping accounts has been traced as far back as 8500 B.C., the date archaeologists have established for certain clay tokens—cones, disks, spheres and pellets—found in Mesopotamia (modern Iraq). These tokens represented such commodities as sheep, jugs of oil, bread or clothing and were used in the Middle East to keep records. The tokens were often sealed in clay balls, called bullae, which were broken on delivery so the shipment could be checked against the invoice; bullae, in effect, were the first bills of lading. Later, symbols impressed on wet clay tablets replaced the tokens. Some experts consider this stage of record keeping the beginning of the art of writing, which spread rapidly along the trade routes and took hold throughout the known civilized world. Account records date back to the ancient civilizations of China, Babylonia, Greece and Egypt. People in these civilizations maintained various types of records of business activities. During the 1* dynasty of Babylonia (2286-2242 6.C.),its law which was based on the Code of “ Hammurabi, requires merchants trading goods to give'buyers a sealed memorandum containing the agreed price before it can be considered enforceable. The agreed-upon transaction was recorded by the Scribe (the predecessor of the modern accountant) on a small mound of clay with the parties affixing “their signatures” on it. This clay was allowed to dry and served as the record of the transaction. For the more important ones, the record can be kiln-dried. * Committee on Accounting History, Report of the Committee, Accounting Review, supplement to Vol. XLV, 1920, p. 53.Accounting and Its Environment | 1-5 ——_———————_— At around 3600 B.C. in Babylonia, clay tablets also recorded payments of wages. The rulers Of these civilizations used accounting to keep track of the costs of labor and materials used in building structures as in the case of the pharaohs of Egypt in building their great pyramids. Accounting is one of our oldest skills. The earliest collections of understandable writing track how many bushels of grain came into the king’s warehouse. Tablets recorded who brought in the grain and how much the king took as his share. Even in the early days, tax collecting is an activity closely linked to accounting. The presence of bookkeeping in the ancient world has been attributed to various factors including (i) the invention of writing; (i) the introduction of Arabic numerals; (ii) the decimal system; (iv) the diffusion of knowledge of algebra; (v) the presence of inexpensive writing materials; (vi) the rise of literacy; and (vii) the existence of a standard medium of exchange. A.C. Littleton in Accounting Evolution to 1900 lists seven preconditions for the emergence of systematic bookkeeping: : The Art of Writing, since bookkeeping is first of all|a record; Arithmetic, since the mechanical aspect of bookkeeping consists of a sequence of simple computations; Private Property, since bookkeeping is concerned only with recording the facts about property and property rights; Money (j.e., among economy), since bookkeeping is unnecessary except as it reduces all transactions in properties or Property rights to this common denominator; Credit (i.e. uncompleted transactions), since there would be little impulse to make any record whatever if all exchanges were completed on spot; Commerce, since a merely local trade would never have created enough pressure (volume of business) to stimulate men to coordinate diverse ideas into a system; Capital, since without capital commerce would be trivial and credit would be inconceivable. Middle Ages As a result of the Crusades from the 11" to the 13" centuries, Northern Italy’s literacy has become widespread. Arabic numerals were also being used as a result of trade with the Near East allowing columns of numbers to be added and subtracted. The use of credit was prevalent and a semblance of an international banking system was also functioning. The Inca Empire, which spanned the west coast of South America throughout the 11" to 14" centuries, used knotted cords of different lengths arid colors called quipu to keep.accounting records. Development of more formal account-keeping methods is attributed to the merchants and bankers of Florence, Venice and Genoa during the 13° to 15" centuries. Double-entry bookkeeping is not a discovery of science; it is the outcome of continued efforts to meet the changing necessities of trade. German philosopher Oswald Spengler wrote in The Decline of the West (1928):that the invention of double-entry bookkeeping was the decisive event in European economic history. The Florentine Approach Renaissance Florentine markets were a fascinating combination of formalization, in the form of account books and double-entry bookkeeping, and of informal social networks, constructed out of the surrounding rules of Florentine sociality. To them, doing business and living life were extensions of each other. Business was conducted on logic of friendship, but friendship in turn was instrumental, as well as emotional. Account books were notWIN Ballada 6 | Basic Financial Accounting and Reporting 2022 Edition by Pr inconsistent with sdcial exchange; rather, they formalized and made social exchange easier The explosion of commercial credit, at that time, required a system of recording. The earliest evidence of business bookkeeping in Florence, France was evidenced by the bank ledger fragments of 1211 (transcribed in 1887 by Pietro Santini) and with the development of accounting in Tuscany, Italy during the 13th century, as evidenced in the account-books or extracts. But, these were within the framework of the “narrative” or “paragraph” type of accounting record (a sezioni sovrapposte), perhaps derived from the “charge and discharge” format used in public accounts. The system was primitive; accounts were not related in any special way (in terms of equality for entries), and balancing of the accounts was lacking. The emergence of double entry itself, was first witnessed in the “ledgers” of Renieri (or Rinieri) Fini & Brothers (1296-1305) and Giovanni Farolfi & Company (1299-1300). vanno Farolfi & Company, as appears from the “ledger”, was a’firm of Florentine merchants whose head office was at Nimes in Languedoc, in the kingdom of France. The ledger, however, relates exclusively to the branch at Salon, a town in the independent county of Provence, Amatino Manucci was a partner in Giovanni Farolfi & Company, a merchant partnership based in Florence. Financial records that he kept for the firm’s branch in Salon, Provence, survive from 1299- 1300. Although these records are incomplete, they show enough detail to be identified as double-entry bookkeeping. These details include the use of debits and credits and duality of entries. They are the oldest known existing examples of the double-entry system. Amatino Manucci was the inventor of double-entry bookkeeping. He managed to construct a comprehensive and fully-articulated set of double-entry records, with a regular balancing procedure on closure of the General Ledger. He used five books—general ledger, two merchandise ledgers, expenses ledger, and cash book (with the white ledger as a sixth)—constituted what looks very like a true double-entry system. In addition, there were at least two subsidiary books. He gave importance to the aspect of financial control. The books were logically subdivided, with segregation of cash and goods accounts from the main ledger, a perpetual inventory of each line of agricultural produce and each grade of cloth or yarn dealt in, and full records of debtors and creditors, expenses, profits, interest and partners’ drawings, as well as the state of account.with the head office at Nimes, and an estimate (15% per annum) of the expected rate of return on capital employed. The Method of Venice Luca Pacioli, a Franciscan friar and a celebrated mathematician, is Lag) generally associated with the lection Woke anny Fam ‘bookkeeping. In 1494 he published his book, Summa de Arithmetica, Geometria, Proportioni et Proportionalita or “Everything about Hwy Arithmetic, Geometry, Proportions and Proportionality,” which includes, Particularis de Computis et Scripturis or “Details of Calculation and Recording,” describing double-entry bookkeeping. His treatise reflected the practices of Venice at the time, which el 2 GA. Lee (1977), “The Coming of Age of Double Entry: The Giovanni Farolfi Ledger of 1299-1300", Accounting Historians Journal, 4(2): 79-95.. Accounting and Its Environment | 1-7 a became known as the Method of Venice or the Italian method. Therefore, he did not invent double-entry bookkeeping, but rather described what were prevalent accounting practices of the day. - Although Pacioli made no claini to developing the art of bookkeeping, he has been regarded n an ting. He stated that the purpose of bookkeeping was “to” ‘give the trader without rlelaytintormatton as to his assets and liabilities.” Pacioli also advised the computation of a periodic profit and the closing of the books. He said, “It is always good » ‘to close the books each year, especially if you are in a partnership with ethic Frequent ~ accounting makes for long friendship.” This Italian bookkeeping prospered with the development of the commercial republics of Italy and the use of the double-entry method in the fourteenth century. ‘geetily the famous German poet and dramatist, referred to double-entry bookkeeping as je of the finest discoveries of human intellect.” Wemeuiamest an eminent economist- sociologist, believed that “double-entry bookkeeping is born of the same spirit as the system ‘of Galileo and Newton.”FUNDAMENTAL BUSINESS MODEL For a business to be successful, it needs to develop a product or service that customers will pay for and thus create a revenue stream. It can be a new product or service that meets specific needs. It can also be a better product or service. Or, it can a product or service that offers a better value proposition. A’business requires investments to enable it to pay for the infrastructure, equipment and personnel. Only after a skillful combination of these elements can a business generate a revenue stream. Figure 1-1 illustrates how a business is structured to provide a customer proposition. The business model is built on five activities: 1. First, the investors provide the required capital for the business. The cash investment will then be held in a bank account. 2. Thejcashiin the business can be: =~ ‘converted into another type of asset that will be used in the business (e.g. equipment) or sold (e.g. inventory); or spent on operating costs such as salaries, rentals and utilities. 3. The combination of business resources provides the basis for producing the products or services.Accounting and its Environment _| 1-13 L) 4 i 4 Business Owner . a Operating Products or —— Cash ‘Assets Services Bank a anks 5 2 5 Retum 2 eae Figure 1-1 Fundamental Business Model 4. The Sale of a product or service generates an asset called ajreceivablé! This asset once collected will produce a cash inflow for the business. \ 5, If there’s an existing debt from banks, the cash inflow from collections will be used to provide the debt providers with interest on their loans to the company. The rest of the cash can be sent back to the cycle by being converted into other assets or spent on operating costs (back to stage 2). In the normal course of business, this whole process will earn profits on which tax will have to be paid. Any profit after tax can continue to be reinvested in the cycle or paid out to the owners as a"retuirn"/on th investments, * The model illustrates the way money flows around a business,and provides the basis of accounting. To manage a business effectively it is important to know how the cash has been spent and how profitable the products or services have been to the business. The availability of this historic information helps management to make judgments on how to improve the performance of business. TYPES OF BUSINESS Although the fundamental business model does not vary, there are infinite ways of applying it to provide the range of products and services that make up the business World. However, the range of products and services can be summarized in seven broad categories, they are as follows:1-14 |_Basic Financial Accounting and Reporting 2022 Edition by Prof. WIN Ballada Type Services Trader Manufacture Raw materials Infrastructure * Financial Insurance Activity Selling people's time Buying and selling Products Designing products, aggregating ‘components and assembling finished products Growing or extracting Faw materials Selling the utilization of infrastructure Receiving deposits, lending and investing money Pooling premiums of many to meet claims of afew Structure Hiring skilled staff and selling their time Buying a range of raw materials and manufactured goods and consolidating them, making them available for sale in locations near to their customers or online for delivery Taking raw materials and using equipment and staff to convert them into finished goods Buyinig blocks of land and Using them to provide raw materials. Buying and operating assets (typically large assets); selling occupancy often in combination with services Accepting cash from depositors and paying them interest; using the money to Provide loans to borrowers, charging them fees and a higher rate of interest than the depositors receive Collecting cash from many customers; investing the money to pay the losses experienced by a few s customers. By understanding the risk accepted and the likelihood of a claim, more Premium income can be earned than claims p: Examples Software development Accounting Legal Wholesaler Retailer Vehicle Assembly Construction Engineering Electricity, Water Food and drink Chemicals: Media Pharmaceuticals, Farming Mining oll Transport (airport operator, airlines, trains, ferries, buses) Hotels Telecoms Sports facilities Property management Bank Investment house InsuranceAccounting and Its Environment | 1-15 FORMS OF BUSINESS ORGANIZATIONS Any of the above types of activities may be performed by a business organization be ita sole proprietorship, a partnership or a corporation. A business generally assumes one of the three forms of organization. The accounting procedures depend on which form the organization takes. (Sole Proprietorship. This business organization has a single owner called the proprietor who generally is also the manager. Sole proprietorships tend to be small service-type (e.g. physicians, lawyers and accountants) businesses and retail establishments. The owner receives all profits, absorbs all losses and is solely responsible for all debts of the business. From the accounting viewpoint, the sole proprietorship is distinct from its proprietor. Thus, the accounting records of the sole proprietorship do not include the proprietor’s personal financial records. (Partnership: A partnership is a business owned and operated by two or more persons who bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing the profits among themselves. Each partner is personally liable for any debt incurred by the partnership: Accounting considers the partnership as a separate organization; distinct from the personal affairs of each partner. See Chapter 12. A corporation is a business owned by its stockholders! It is an artificial being created by operation of law, having the rights of succession and the powers, attributes and properties expressly authorized by law or incident to its existence. The stockholders are not personally liable for the corporation's debts. The corporation is a ‘separate legal entity: See Chapter 14.PURPOSE AND PHASES OF ACCOUNTING The accounting function is part of the broader business system, and does not operate in isolation. It handles the financial operations of the business but also provides information and advice to other departments. Business transactions are the economic activities of a business. Recording these historical events is @ significant function of accounting. Accounts are produced to aid management in planning, control and decision-making and to comply with regulations. Before the effects of transactions can be recorded, they must be measured. In order that accounting information will be useful, it must be expressed in terms of a common financial denominator—money. (Money, serves as both a medium of exchange and a measure of value. . To meastire a business transaction, the accountant must decide when the transaction occurred (recognition issue), what value to place on the transaction (valuation issue) and how the components of the transaction should be classified (classification issue). By simply measuring and recording transactions, the resulting information will be of limited use. To be useful in making decisions, the recorded data must be classified and earariced: Fj duces the effects of numerous transactions: into useful groups or categories. Gumpaiestich of financial data is achieved through the ‘preparation of financial statements. These summarize the effects of all business transactions that occurred during some period.1-18 | Basic Financial Accounting and Reporting 2022 Edition by Prof. WIN Ballada Ss After going through the preceding phases, it is imperative that the result of the summarization phase be interpreted or analyzed to evaluate the, liquidity, profitability and solvency of the business organization. Accounting provides the decision-makers with information to make reasoned choices among alternative uses of scarce resources in the conduct of business and economic activities. PACIOLI’S DOUBLE-ENTRY BOOKKEEPING AND ITS EVOLUTION In Fra Luca Pacioli’s book, Summa, there are 36 short chapters on bookkeeping. Luca states that to be successful every merchant needs three essential things: sufficient cash or credit, a good bookkeeper, and an accounting system to view the business affairs ata glance. He discusses three books in the Summa: the memorandum, the journal and the ledger. In Pacioli’s book, he introduces the double-entry accounting system—in which for every debet dare (should give) there exists a debet habere (should have or should receive). Modern bookkeeping systems are still based on principles established in the 15" century, although they have had to be adapted to suit modern conditions. In Summa, the memorandum is the book where all transactions are recorded, in the currency in which they are conducted, at the time ‘they are conducted. The memorandum, prepared in chronological order, is a narrative description of the business's economic events. The memorandum is necessary because there are no documents to support transactions. The second book, the journal, is the merchant's private book. The entries made here are in one currency, in chronological order, and in narrative form. The last book, known as the ledger, is an alphabetical listing of all the business’s accounts along with the running balance of each particular account. What is interesting is that Pacioli never discusses financial statements, that is, statements prepared to communicate the results of business activities to interested users. At that time, financial statements are unnecessary because businesses are still closely controlled by owners who can examine the business's records. However, Pacioli does advocate an annual balancing to determine the success or failure of the'business and to find errors. Why has a recording system devised in medieval times lasted for so long? There are two main reasons: it provides an accurate record of what has happened to a business over a specified period of time; and information extracted from the system can help the owner or the manager operate the business much more effectively. ' i In essence, the system provides the answers to three basic questions which owners want to know: What profit has the business made? How much does the business owe? How much is owed to it?The medieval system dealt largely with simple agricultural and trading entities. Modern systems have to reflect complex industrial operations and sophisticated financial arrangements. Furthermore, a business may be so big or so complex nowadays that the owners have to employ managers to run it for them. Indeed, the senior managers themselves may largely depend upon their junior colleagues to tell, them what is happening. A traditional bookkeeping system did not have to deal with situations where owners: were separated from managers. It was designed largely to supply summarized information only to the owner-managers of a business who knew in detail from their own experience what was going on. The system was not intended to cope with frequent day-to-day reporting remote from production or trading operations. As a result, Pacioli’s system had to be adapted for modern business practice so that it can satisfy the demand for information from two main sources: 1. from owners, who want to know from time to time how the business is doing; 2. from the managers, who need information in order to help plan and control it. Owners and managers do not necessarily require the same information and so based on this accounting has developed into two main specializations: 1, Financial Accounting, which is concerned with the supply of information to the owners of an entity; and 2. Ng, which is concerned with the supply of information to the managers of an entity. While it is useful to classify accounting into these two broad categories, accountants are now involved in supplying information to a wide range of other interested parties, such as customers, employees, governments and their agencies, investors, lenders, the public and suppliers and other trade creditors. FUNDAMENTAL CONCEPTS Several fundamental concepts underlie the accounting process. In recording business transactions, accountants should consider the following: \Entity!(Coneapt! The most basic concept in accounting is the entity concept. An accounting entity is an organization or a section of an organization that stands apart from other organizations and individuals as a separate economic unit. Simply put, the transactions of different entities should not be accounted for together. Each entity should be evaluated separately. Twenodienvaconsspia| *" entity's life can be meaningfully subdivided into equal time periods for reporting purposes. It will be aimless to wait for the actual last day of operations to perfectly measure the entity’s profit. This concept allows the users to obtain timely information to serve as a basis on making decisions about future activities. For the purpose of reporting to outsiders, one years the usual accounting period1-20 | Basic Financial Accounting and Reporting 2022 Edition by Prof. WIN Ballada ‘Stable Monetary Unit Concept. The Philippine peso is a reasonable unit of measure and that its purchasing power is relatively stable. It allows accountants to add and subtract Peso amounts as though each peso has the same purchasing power as any other peso at any time. This is the basis for ignoring the effects of inflation in the accounting records. ‘Going Concern! Financial statements are normally prepared on the assumption that the reporting entity is a going concern and will continue in operation for the foreseeable future, Hence, it is assumed that the entity has neither the intention nor the need to enter liquidation or to cease trading. This assumption underlies the depreciation of assets over their useful lives. The COVID19 pandemic continues to cause significant deterioration in economic conditions for many entities worldwide. The economic uncertainties may cast doubt on the entity's ability to continue as a going concern. CRITERIA FOR GENERAL ACCEPTANCE OF AN ACCOUNTING ‘PRINCIPLE Accounting practices follow certain guidelines. GAAP, which stands for generally accepted accounting principles, encompass the conventions, rules and procedures necessary to define accepted accounting practice at a particular time. Accounting principles are established by humans. Unlike ‘the principles of physics, chemistry, and the other natural sciences, accounting principles were not deduced from basic axioms, nor can they be verified by observation and experiment. Instead, they have evolved, This evolutionary process is going on constantly; accounting principles are not eternal truths, The general acceptance of an accounting principle usually depends on how well it meets three criteria: relevance, objectivity and feasibility. 1. Aprinciple has ‘relevance to the extent that it results in information that is meaningful and useful to those who need to know something about a certain organization. 2. Aprinciple has objectivity to the extent that the resulting information is not influenced by the personal bias or judgment of those who furnish it. Objectivity connotes reliability and trustworthiness. It also connotes verifiability, which means that there is some way of finding out whether the information is correct. 3. A principle has (feasibility to the extent that it can be implemented without undue complexity or cost. These criteria often conflict with one another. In some cases, the most relevant solution may be the least objective and the least feasible. BASIC PRINCIPLES In order to generate information that is useful to the users of financial statements, accountants rely upon the following principles: Objectivity Principle. Accounting records and statements are based on the most reliable data available so that they will be as accurate and as useful as possible. Reliable data are verifiable when they can be confirmed by independent observers. Ideally, accounting records are based on information that flows from activities documented byironment | 1-21 Accounting and Its En\ objective evidence. Without this principle, accounting records would be based on whims and opinions and is therefore subject to disputes. Historical Cost. This principle states that acquired assets should be recorded at their actual cost and not at what management thinks they are worth as at reporting date. Revenue Recognition Principle. Revenue is to be recognized in the accounting period when goods are delivered or services are rendered or performed. Expense Recognition Principle. Expenses should be recognized in the accounting period » in which goods and services are used up to produce revenue and not when the entity pays for those goods and services. Adequate Disclosure. Requires that all relevant information that would affect the user's understanding and assessment of the accounting entity be disclosed in the financial statements. Materiality. Financial reporting is only concerned with information that is significant enough to affect evaluations and decisions. Materiality depends on the size and nature of the item judged in the particular circumstances of its omission, In deciding whether an item or an aggregate of items is material, the nature and size of the item are evaluated together. Depending on the circumstances, either the nature or the size of the item could be the determining factor. Consistency Principle. The firms should use the same accounting method from period to period to achieve comparability over time within a single enterprise. However, changes are permitted if justifiable and disclosed in the financial statements.BRANCHES OF ACCOUNTING The work that accountants undertake ranges far beyond that of simply summarizing information in order to calculate how much profit a business has made, how much it owes, and how much is owed to it: Although this work is still very important, ‘accountants are involved in other types of work. Of course, other information specialists (such as market researchers and operations analysts) have also been drawn into the preparation of management information, and at one time, some observers expected accounting to be taken over by these newer and mores scientifically-based disciplines. However, this has not happened. There are three main reasons: 1. Financial information supplied to external users still has a dominant influence on internal management information; 2. Other information specialists have been reluctant to become involved in detailed accounting matters; and 3. an have been quick to absorb new methods and techniques into their work.——___. Accounting and Its Environment | 1-45 The main branches of accounting and their brief descriptions are discussed as follows: Auditing \Auditinglis the accountancy profession’s most significant service to the public. An external audit is the independent examination that ensures the fairness and reliability of the reports that management submits to users outside the business entity. The result of the examinations is embodied in the independent auditor’s report. Once the required financial statements have been prepared by management, they have to be evaluated in order to ensure that they do not present a distorted picture. External auditors are appointed from outside the organization. The external auditor's job is to protect the interests of the users of the financial statements. By contrast, internal auditors are employees of the company. They are appointed by, and answer to, the company’s management though they work independently of the accounting and other departments. They ensure the accuracy of business records, uncover internal control problems and identify operational difficulties. To differentiate further, internal auditors perform routine tasks and undertake detailed checking of the company’s accounting procedures, whereas external auditors are likely to go in for much more selective testing. Nonetheless, they usually work very closely together, although the distinction made between them still remains\important. Bookkeeping {Bookkéépinglis a mechanical task involving the collection of basic financial data. The data are first entered in the accounting records or the books of accounts, and then extracted, classified and summarized in the form of income statement, balance sheet and cash flows statement. This process normally takes place once a month. An income statement shows whether the business has made a profit or loss during the period, i.e. it measures how well the business has done. A balance sheet lists what the entity owns (its assets), and what it owes (its liabilities) as at the end of the period. The cash flows statement presents the cash inflows and outflows of the business during the period The bookkeeping procedures usually end when the basic data have been entered in the ‘books of accounts and the accuracy of each entry has been’ tested. At that stage, the accounting function takes over. Accounting tends to be used as a generic term covering almost anything to do with the collection and use of basic financial data. It should, however, be more properly applied to the use to which the data are put once they have been extracted from the books of accounts. Bookkeeping is a routine operation, while accounting requires the ability to examine a problem using both financial and non- financial data.1.46 | Basic Financial Accounting and Reporting 2022 Edition by Prof. WIN Ballada Cost Bookkeeping, Costing, and Cost Accounting ‘Cost bookkeeping is the process that involves the recording of cost data in books of accounts. It is, therefore, similar to bookkeeping except that data are recorded in very much greater detail. Cost accounting makes use of those data once they have been. extracted from the cost books in providing information for managerial planning and control. Accountants are now discouraged from using the term ‘costing’ unless it is qualified in some way, i.e. by referring to some branch of costing (such as standard costing), but even so you will still find the term ‘costing’ in general use. The difference between bookkeeping per se and cost bookkeeping is largely one of degree of detail. A cost accounting system contains a great deal more data, and thus once the data are summarized there is much more information available to the management of the company. Cost accounting deals with the collection, allocation, and control of the cost of producing specific goods and services. This accumulation and explanation of actual and prospective cost data is important to control current Operations and to plan for the future. Cost accounting now forms one of the main sub- branches of management accounting. Financial Accounting ‘Financial accounting is focused on the recording of business transactions and the periodic preparation of reports on financial position and results of operations. Financial accountants accord importance to generally accepted accounting principles. Financial accounting is the more specific term applied to the preparation and subsequent publication of highly summarized financial information. The information supplied is usually for the benefit of the owners of an entity, but it can also be used by management for planning and control purposes. It will also be of interest to other parties, e.g. employees and creditors. Financial Management [Financial management is a relatively new branch of accounting that has grown rapidly over the last 30 years. Financial managers are responsible for setting financial objectives, making plans based on those objectives, obtaining the finance needed to achieve the plans, and generally safeguarding all the financial resources of the entity. Financial managers are much more heavily involved in the management of the entity than is generally the case with either financial or management accountants. It should also be noted that the financial manager draws on a much wider range of disciplines (such as economics and mathematics) and relies more extensively on non-financial data than does the more traditional accountant. Management Accounting 7 5 incorporates cost accounting data and adapts them for specific decisions which management may be called upon to make. A management accountingSSS Accounting and Its Environment | 1-47 system incorporates all types of financial and non-financial information from a wide range of sources. Taxation Tax accounting includes the preparation of tax returns and the consideration of the tax consequences of proposed business transactions or alternative courses of action. As typically known, accountants involved in tax work are responsible for computing the amount of tax Payable by both business entities and individuals but their work is really more complex. Accountants with this specialization aim to comply with existing tax statutes but are also in constant legal search for ways to minimize tax payments. It is not necessary for either companies or individuals to pay more tax than is lawfully due. If tax experts attempt to reduce their clients’ tax liabilities strictly in accordance with the law, this is known as ‘tax avoidance’. Tax avoidance is a perfectly legitimate exercise, but tax evasion (the non-declaration of sources of income on which tax might be due) is avery serious offense. Government Accounting . It is concerned with the identification of the sources and uses of resources consistent with the provisions of city,-municipal, provincial or national laws. The government collects and spends huge amount of public funds annually so it is necessary that there is proper custody and disposition of these funds.