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FINACIAL ACCOUNTING AND REPORTING

BASIC PRINCIPLES OF ACCOUNTING

M. SAGUN, CPA

DEFINITION OF ACCOUNTING
 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 is an information system that measures, processes and

communicates financial information about an economic entity

 Accounting is the process of identifying, measuring and communicating

economic information to permit informed judgments and decisions by
users of the information

 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 a financial character, and interpreting the
results thereof

TYPES OF BUSINESS

Type Activity Structure Examples

Services Selling people’s Hiring skilled staff  Software
time and selling their development
time  Accounting
 Legal
Trader Buying and selling Buying a range of  Wholesaler
products raw materials and  Retailer
manufactured goods
and consolidating
them, making them
available for sale
in location near to
their customers or
online for delivery
Manufacture Designing products, Taking raw materials  Vehicle assembly
aggregating and using equipment  Construction
components and and staff to convert
 Engineering
assembling finished them into finished
products goods  Electricity, Water
 Food and Drink
 Chemicals
 Media
 Pharmaceuticals
Raw Materials Growing or Buying blocks of  Farming
extracting raw land and using them  Mining
materials to provide raw
 Oil
materials
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Infrastructure Selling the Buying and operating  Transport (airport

utilization of assets (typically operator, airlines,
infrastructure large assets); trains, ferries,
selling occupancy buses)
often in combination  Hotels
with services
 Telecoms
 Sports facilities
 Property management
Financial Receiving deposits, Accepting cash from  Bank
lending and depositors and  Investment houses
investing money paying them
interest; using the
money to provide
loans to borrowers
charging them fees
and a higher rate of
interest than the
depositors receive
Insurance Pooling premiums of Collecting cash from  Insurance
many to meet claims many customers;
of a few investing the money
to pay the losses
experienced by a few
customers. By
understanding the
risk accepted and
the likelihood of a
claim, more premium
income can be earned
than claims paid

FORMS OF BUSINESS ORGANIZATION

 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 comment 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.

 Corporation. 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
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not personally liable for the corporation’s debts. The corporation is a

separate legal entity

ACTIVITIES IN BUSINESS ORGANIZATIONS

 Financial Activities. Organizations require financial resources to
obtain other resources used to produce goods and services. They compete
for these resources in financial markets. Financing activities are the
methods an organization uses to obtain financial resources from
financial markets and how it manages these resources. Primary sources
of financing for most businesses are owners and creditors, such as
banks and suppliers. Repaying the creditors and paying a return to the
owners are also financing activities.

 Investing Activities. Managers use capital from financing activities to

acquire other resources used in the transformation process—that is, to
transform resources from one form to a different form, which is more
valuable, to meet the needs of the people. Having the right mix of
resources is essential to efficient and effective operations.

 Operating Activities. Operating activities involve the use of resources

to design, produce, distribute and market goods and services. Operating
activities include research and development, design and engineering,
purchasing, human resources, production, distribution, marketing and
selling, and servicing. Organizations compete in supplier and labor
markets for resources used in these activities. Also, they compete in
product markets to sell the goods and services created by operating
activities.

PURPOSE 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 a significant function of
accounting. Accounts are produced to aid management in planning, control
and decision-making and to comply with regulations.

FUNDAMENTAL CONCEPTS
 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

 Periodicity Concept. An entity’s life can be meaningful subdivided into

equal time period 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 user to obtain timely information to
serve as a basis on making decisions about future activities. For the
purpose of reporting to outsiders, one year is the usual accounting
period.
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 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 anytime. This is the
basis of ignoring the effects of inflation in the accounting records.

CRITERIA FOR GENERAL ACCEPTANCE OF AN ACCOUNTING PRINCIPLE

 Relevance. A principle 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

 Objectivity. A principle has objectivity to the extent that the

resulting information is not influenced by the personal basis or
judgment or 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

 Feasibility. 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
 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 objective
evidence. Without this principle, accounting records would be based on
whims and opinions and is therefore subject to disputes.

 Historical Cost. This principles 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.
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 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 or 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 of 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.

ELEMENTS OF FINANCIAL STATEMENTS

Financial Position
 Assets. Assets are resources controlled by the enterprise as a
result of past events and from which future economic benefits are
expected to flow to the enterprise.

 Liabilities. Liabilities are obligations of the entity to outside

parties who have furnished resources. Liability is a present
obligation of the enterprise arising from past events, the
settlement of which is expected to result in an outflow from the
enterprise of resources embodying economic benefits.

 Equity is the residual interest in the asset of the enterprise after

deducting all its liabilities.

Performance
 Income. Income is increases in economic benefits during the
accounting period in the form of inflows or enhancement of assets or
decreases of liabilities that result in increases in equity. Other
than those relating to contributions from equity participants. The
definition of income encompasses both revenue and gains.

 Revenues. Revenue arises in the course of the ordinary activities of

an enterprise.

 Gains. Gains represent other item that meet the definition of income
and may, or may not, arise in the course of the ordinary activities
of an enterprise

 Expenses. Expenses are decreases in economic benefits during the

accounting period in the form of outflows or depletions of assets or
incurrence of liabilities that result in decreases in equity, other
than those relating to distributions to equity participants. The
definition of expenses encompasses losses as well as those expenses
that arise in the course of the ordinary activities of the
enterprise.
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 Losses represent other items that meet the definition of expenses

and may or may not, arise in the course of the ordinary activities
of the enterprise.

………………………………NOTHING FOLLOWS………………………………
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Name: ______________________________ Score: ____________________

Year/Course/Section: _______________ Schedule:__________________

Multiple Choice: Choose the best answer:

1. Which of the following is an appropriate definition of accounting?

a. A means of recording transactions and keeping records
b. Electronic collection, organization and communication of vast amounts
of information
c. The interconnected network of subsystems necessary to operate a
business
d. The measurement, processing, and communication of financial
information about and identifiable economic entity

2. Which accounting process is the recognition and non-recognition of business

activities as accountable events?
a. Communicating c. Measuring
b. Identifying d. Recording

3. During the lifetime of an entity, accountants produce financial statements

at arbitrary points in time in accordance with which basic accounting
concept?
a. Conservatism c. Objectivity
b. Matching d. Periodicity

4. The periodicity concept:

a. Involves dividing the life of a business entity into accounting
periods of equal length thus enabling the financial users to
periodically evaluate the results of business operations
b. Requires all companies to use a fiscal year ending December 31
c. Requires that all companies prepare monthly, quarterly and annual
financial statements
d. Results from the Bureau of Internal Revenue requirement that taxable
income be reported on an annual basis

5. The communication phase of accounting is accomplished by:

a. Processing data c. Reporting to decision makers
b. Recording data d. Storing data

6. Accounting is a service activity. Its function is to provide:

a. Qualitative information
b. Quantitative and qualitative information
c. Quantitative information
d. None of the above

7. The concept of the accounting entity is applicable:

a. Only to business organizations
b. Only to the economic aspects of business organizations
c. Only to the legal aspects of business organizations
d. Whenever accounting is involved

8. They encompass the conventions, rules, and procedures necessary to define

what is accepted accounting practice
a. Accounting assumptions c. Conceptual frameworks
b. Accounting concepts d. Generally accepted accounting
principles
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9. The financial statements should be stated in terms of a common financial

denominator:
a. Accrual c. Stable monetary unit
b. Going concern d. Time period

10. This principle requires relevant information to form part of financial

statements for decision-making purposes:
a. Accounting entity c. Materiality
b. Adequate disclosure d. Objectivity