Overview of Accounting

Learning Objectives 
• Define accounting and state its basic purpose. 
• Explain the basic concepts applied in accounting. 
• State the branches of accounting and the sectors in the  practice of accountancy. 
• Explain the importance of a uniform set of financial  
reporting standards.

Definition of Accounting 
• Accounting is “the process of identifying,  measuring, and communicating economic  information to
permit informed judgment and  decisions by users of information.”

Three important activities 

1. Identifying - the process of analyzing events and transactions to  determine whether or not they will
be recognized. Only  
accountable events are recognized. 
2. Measuring - involves assigning numbers, normally in monetary  terms, to the economic transactions
and events. 
3. Communicating - the process of transforming economic data  into useful accounting information,
such as financial statements  and other accounting reports, for dissemination to users. 
Types of Events 
1. External events – events that involve an external party.
a. Exchange (reciprocal transfer) – reciprocal giving and  receiving 
b. Non-reciprocal transfer – “one way” transaction
c. 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.  
2. Internal events – events that do not involve an external party. 
d. Production – the process by which resources are transformed  into finished goods.  
e. Casualty – an unanticipated loss from disasters or other  similar events.  
Measurement  
• The several measurement bases used in accounting include, but not  limited to, the following:  
1. historical cost,  
2. fair value,  
3. present value,  
4. realizable value,  
5. current cost, and  
6. sometimes inflation-adjusted costs.  

• The most commonly used is historical cost. This is usually combined  with the other measurement
bases. Accordingly, financial statements are  said to be prepared using a mixture of costs and values.  
Valuation by fact or opinion 
• When measurement is affected by estimates, the items  measured are said to be valued by opinion.  
• When measurement is unaffected by estimates, the items  measured are said to be valued by fact. 
Basic purpose of accounting  
• The basic purpose of accounting is to provide  information about economic activities intended to be 
useful in making economic decisions.  
Types of accounting information classified as to  users’ needs 
• General purpose accounting information - designed to  meet the common needs of most statement
users. This  information is governed by the Philippine Financial  Reporting Standards (PFRSs). 
• Special purpose accounting information - designed to  meet the specific needs of particular statement
users.  This information is provided by other types of  accounting, e.g., managerial accounting, tax basis 
accounting, etc. 
Basic Accounting Concepts 
• Double-entry system – each accountable event is recorded in two parts – debit and credit. 
• Going concern - the entity is assumed to carry on its operations for an  indefinite period of time. 
• Separate entity – the entity is treated separately from its owners. 
• Stable monetary unit - amounts in the financial statements are stated  in terms of a common unit of
measure; changes in purchasing power are  ignored. 
• Time Period – the life of the business is divided into series of reporting  periods.  
• Materiality concept – information is material if its omission or  misstatement could influence
economic decisions.  
• Cost-benefit – the cost of processing and communicating information 

Basic Accounting Concepts - Continuation 

• Accrual Basis of accounting – effects of transactions are  recognized when they occur (and not as cash
is received or paid) and  they are recognized in the accounting periods to which they relate. 
• Historical cost concept – the value of an asset is determined on  the basis of acquisition cost. 
• Concept of Articulation – all of the components of a complete  set of financial statements are
interrelated.  
• Full disclosure principle – financial statements provide  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. • Consistency concept – financial
statements are prepared on the  basis of accounting policies which are applied consistently from one 
period to the next.  
Basic Accounting Concepts - Continuation • Matching – costs are recognized as expenses when the
related  revenue is recognized.  
• Residual equity theory – this theory is applicable where there  are two classes of shares issued,
ordinary and preferred. The  equation is “Assets – Liabilities – Preferred Shareholders’ Equity =  Ordinary
Shareholders’ Equity.” 
• Fund theory – the accounting objective is the custody and  administration of funds.  
• Realization – the process of converting non-cash assets into cash  or claims for cash.  
• Prudence (Conservatism) – the inclusion of a degree of caution in  the exercise of the judgments
needed in making the estimates  required under conditions of uncertainty , such that assets or income 
are not overstated and liabilities or expenses are not understated. 

Common branches of accounting 

• Financial accounting - focuses on general purpose financial  statements. 
• Management accounting – focuses on special purpose financial  reports for use by an entity’s
management. 
• Cost accounting - the systematic recording and analysis of the costs of  materials, labor, and overhead
incident to production. 
• Auditing - the process of evaluating the correspondence of certain  assertions with established criteria
and expressing an opinion thereon.
• Tax accounting - the preparation of tax returns and rendering of tax  advice, such as the determination
of tax consequences of certain  proposed business endeavors. 
• Government accounting - refers to 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. 

Four sectors in the practice of accountancy  

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 CPA. 
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
technically  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 where
decision  making requires professional knowledge in the science of accounting, or  where civil service
eligibility as a CPA is a prerequisite. 
Accounting standards in the Philippines 
• Philippine Financial Reporting Standards (PFRSs) are Standards and Interpretations adopted by the
Financial Reporting  Standards Council (FRSC).

They comprise: 
1. Philippine Financial Reporting Standards (PFRSs);
2. Philippine Accounting Standards (PASs); and 
3. Interpretations 

The need for reporting standards 

• Entities should follow a uniform set of generally acceptable reporting  standards when preparing and
presenting financial statements; otherwise,  financial statements would be misleading.  
• The term “generally acceptable” means that either:  
a. the standard has been established by an authoritative accounting  rule-making body; or 
b. the principle has gained general acceptance due to practice over time  and has been proven to be
most useful.  
• The process of establishing financial accounting standards is a democratic  process in that a majority of
practicing accountants must agree with a  standard before it becomes implemented. 

Basic Accounting Equation

A = L + OE

Inventory is an asset and it is recorded in balance sheet. Inventory can be any physical property,
merchandise, or other goods items that are held for resale, to be sold at a future date. 

Types of Inventory

Manufacturing Inventory - 
•raw materials, 
•work-in-process, 
•finished goods

Merchandising Inventory - goods are acquired for resale

Inventories are measured at the lower cost and net realizable value. 

Initial Measurement - Cost 

Subsequent Measurement - LCNRV
Net Realizable Value = Estimated Selling Price – Estimated Costs to Complete – Estimated Costs to Sale
Net realizable value or NRV is the estimated selling price of goods, minus 
the estimated cost of completion and the estimated cost necessary to make the sale. 

Cost Formula expressly provides that the cost of inventories shall be determined by using either: 
1. First in, First out
2. Weighted average 

The cost of inventories that are not interchangeable and inventories that are segregated for specific
project shall be determined by using specific identification method.

The FIFO method assumes that "the goods first purchased are the first sold".

Weighted Average
Costs of sales and ending inventory are determined based on the weighted average cost of the
beginning inventory and all inventories purchased during the period may be calculated on periodic table.

Net Realizable Value as Expense

If inventory is written down to NRV, the write- down is charged to expense, which means net income
and tax liability reduced.

Statement of Cash Flows

It is a financial statement that summarizes the amount of cash flowing in and out of a company.

Classifications of Cash Flows

1. Operating Activities - Daily activities of a company involved in producing and selling goods,
generating revenues, as well as administrative and maintenance activities. 
 EXAMPLES: payments of suppliers, cash received from customers, payments of insurance and
taxes, and administrative and utility expenses.

2. Investing Activities - It involves the long-term uses of cash. Purchase or sale of fixed assets like
property, plant, and equipment (PPE).   
                             
EXAMPLE: Purchasing and selling of properties and equipment.

3. Financing Activities - It shows the net flows of cash that are used to fund the company. 

EXAMPLES: issuance and repayment of equity, issuance and repayment of debt.

Methods in preparing statement of cash flows

1. Direct Method – Operating cash flows are presented as a list of ongoing and outgoing cash
flows.
2. Indirect Method – Operating cash flows are presented as a reconciliation from profit to cash
flow.

Basic Accounting Equation

A = L + OE

Normal Balance of Accounts

DEBIT CREDIT
Assets Liabilities
Withdrawals Income
Expenses Capital

Income – Expense
Total Income > Total Expense = Net Income / Profit
Total Income < Total Expense = Net Loss

Transaction Effects A = L + OE
Received cash as additional investment + O +
Purchased supplies on account + + O
Acquired equipment, paying 50% down, balance due in 30 days + + O

Permanent Accounts – no need for closing entries (balance sheets)

Temporary Accounts – needs closing entries (income statement)

Balance Sheet Income Statement

Assets Revenue
Liabilities Expense
Owner’s Equity Net Income

Recording - writing accountable transactions & events in the books of business.

Classifying – categorizing similar items into the same group or same name.
Summarizing – creating a condensed version of the recorded & classified information.
Interpreting – explanation of data recorded, classified, & summarized.
Accounting Period – span of time In which a set of financial statements are released.
Journal – book of entries
Posting – journal to ledger
Trial balance – debit = credit
Footing – getting final balance