"EDITION ZENAIDA VERA CRUZ MANUEL a = £ Scanned with CamScannerCHAPTER 1 INTRODUCTION TO ACCOUNTING AND BUSINESS LEARNING OUTCOMES After studying this chapter, you should be able to: describes the role of accounting in your personal life describes the role of accounting in business, defines business and explains its motive and role in society, describes the nature of a business, its form of or describes the role of management in business, defines accounting and explains its relevance to stakeholders identifies the stakeholders and describes their role as decision-makers in business. defines accounting information system and discusses the fundamental system principles discusses the contents of the financial reports and explains the financial information contained herein. ganization, and type of operation. This chapter will surely catch your attention as it opens the door of accounting for you. It will be interesting to find out how accounting relates to one’s personal life. And since accounting is part of a business organization, it is important to give you an eye view of what a business is all about. Refer to Figure I.1 below: BUSINESS FIRMS DECISION-MAKERS MAX'S PUREFOODS SM_ Goldilocks OWNERS MANAGERS LENDERS i le. The success of a business hinges on quality service. Behind this suecess fs Tet) Accountants will show you how the business activities are shaped into wT ‘ports which provide these people with much-needed information so (hey and timely decisions for the firm to succeed. i cou A summary of the basic concepts that shape seoputng, in iil sone e correct se and profession are i ; vepts and the Biven in Fig 1.2 Page 2. The very essence of Accounting: it while the formal financial reports 10: be a acd ae illustrated in the first four pane are discussed in ‘counting records and the proper presentation of the financial! 1 hapters 5 to 7, Scanned with CamScannerFigure 1.2 BASIC CONCE! Chapter 1 Chapter 2 Chapter 3 Chapter 4 Importance of Fundamental Changes | Accounting Transaction Accounting, inthe 21" Century, | Principl h ct ' ples, Analysis to operat Business and its Role | Attitude, Skills, and | Transaction Analysis | business, Changesia in Society, Users and | Knowledge, tostart a business, | Capital, Expanded their Needs, Regulating Bodi Accounting Equation | Accounting Accounting Accounting Areas, | Illustrated, Equation Illustrated, Information System, | Accounting Preparation of the | Preparation of the Accounting Reports. | Framework, Good Statement of Profit or Loss Governance, thics, inancial Position. ‘Statement. ACCOUNTING IS PART OF DAILY LIFE You encounter accounting in your daily routine not knowing that you are doing some accounting activity. As a student, you get an allowance from your parents and use this to pay for certain expenses like transportation fare, food, and school supplies, among others. At the end of the day, some of you have consumed your allowance while others may have saved something and plan to use it in the future. The process of receiving money, planning and allocating it according to one’s needs is a simple way of Budgeting. This is one important area in accounting. Most of the time, what you do is part of the accounting process. When you board a public utility vehicle, be it a jeep or a bus, you pay your fare. All the fares received by the driver represent his REVENUES. But, he has to spend on gasoline, vehicle repairs, and the operator’s (owner of the vehicle) boundary fee. These represent his EXPENSES. The amount of revenues lefi after paying for the expenses would be his take-home revenue or NET INCOME. When you pay for food bought from the school’s canteen this represents revenue. Expenses have to be paid such as salaries of the cook and server, electricity, water, office supplies and the food supplies (meat, pork, fish, fruits, and vegetables). Again, the amount of revenue left after deducting the expenses would be the canteen’s profit or net income. Tuition fee has to be paid when you enroll. This becomes the school’s revenue and then again expenses have to be paid such as salaries of the teachers and staff, supplies, utilities, and repairs of the buildings and furniture. Then again, the net amount left after deducting all the expenses from the tuition fee revenues would be the school’s net income. The above examples describe how one operates a business to earn profit. But wait, when you talk about business and profit, you are talking about wealth or net worth, WHAT IS NET WORTH AND WHY IS THIS IMPORTANT? Net worth represents your Wealth or Finance which is made up of properties or assets. You probably own several gadgets such as computer, cellphone, iPad, iPhone, as well as clothes, shoes, bags and which amount to two hundred thousand pesos (P200,000). These are your ASSETS that make up your wealth or NET WORTH, However, if the computer was purchased for forty thousand pesos (P40,000) using a credit card, then not all the assets belong to you. The credit company has a claim over the computer. This is a LIABILITY of obligation to pay which will decrease your net worth from P200,000 assets minus P40,000 liability equals your NET WORTH which is now only P160,000 pesos. 2 Scanned with CamScannerNet Worth affects your status in life. For one, a big net worth means a stable life. Second, knowing how much is your net worth helps you plan on how to improve it and make it grow. Knowing how much is your net worth at the end of every year will give you a clear picture of where your wealth or.finances are going. Has it been growing (if you have more assets than liabilities) or deteriorating? FfSm Four P160,000 net worth, if you borrow cash of P50,000, will your net worth improve? No. Although your assets will grow, so will your liabilities, too. It is only profit that will make your net worth grow. Ifyou are a student or a fresh graduate, you will probably have a low net worth. Try to build your assets by saving or putting aside a certain percentage of your allowance. Plan your spending, so you have extra cash (savings) which can deposit in the bank and your money will grow or cam interest, Is there a better way to make your net worth grow? If you are enterprising and possess business acumen (skill + gut fecling + luck), the best way to make your money and other resources grow is to put up a business. Think of goods that you can sell to your classmates and friends, or think of how you can put to good use your artistic or creative skills, If you are good in baking, you can sell cookies or cupcakes to your neighbors or classmates. You can do it online. Go over the internet and view the different products or services. I know of one who is a coffee lover. She scarched over the internet for the best coffee, tasted these, made a choite on which to sell online and became a successful entrepreneur! It started with passion for good coffee. NET WORTH AND ACCOUNTING If you are using your money for a business venture, you must make a record of the progress of your financial activities. Here is where accounting comes in: track down the activities of your business from the time you use money to buy goods, pay for operating expenses and sell and collect monies from the customers. How does profit come about? Compare: ( Moncy RECEIVED Money PAID for buying goods from selling goods and incurring expenses = | PROFIT v With profit, assets will grow and so will net worth. However, it is not possible to memorize your assets and liabilities and the changes that will occur over time. The best way is to make a “diary” or record. Accounting does this for you: 1) tracks down business activities and analyzes these, 2) calculates (or measures) and records 3) prepares a progress report These three steps are the first part of the accounting process called Bookkeeping. You must understand at the dutset that Accounting is a professional field made up of several areas of work, the very basic of which is bookkeeping or record making, This book will deal mainly with the bookkeeping area of accounting Some chapters, however, include an interpretation of the financial reports called Financial Analysis which is another area in accounting, Note that author mentioned in bold letters six of the most important accounting terms: ASSETS, LIABILITIES, NET WORTH, REVENUES, EXPENSES, PROFIT and three accounting areas - BUDGETING, BOOKKEEPING AND FINANCIAL ANALYSIS. YOU ARE A DECISION MAKER ‘When you plan to put up your own business with the will need answers to the following questions: assets you have accumulated, you + Scanned with CamScanner1) DoT have sufficient knowledge, skills and interest in the product or service | want to offer? 2) Do! have enough capital or money to start a business? If not, how do I raise enough funds? 3) What other resourees, aside from cash, does this business need to operate well? 4) How much are the operating costs that I need to pay? 5) Where should | locate the busine 6) What will be a reasonable price to offer for my products or services? 7) Should | always follow the price of the competitor? You need to prepare a feasibility study that will help you answer these questions and enable you to make the right decisions regarding the business you want to put up. You need business knowledge and accounting knowledge to be able to prepare a good business plan. Four factors are making up the knowledge base which is explained in Chapter 2. BUSINESS AND ACCOUNTING. Let us now connect accounting to your business venture. You must know how to manage the assets of your business so that you will be able to produce more wealth. From accounting, you will get the information that you need to ensure your business is in the right direction, and that you are operating (performing) profitably. More assets must be obtained as a result of the operation, to give the business a larger net worth than when it started operation. Knowing how accounting works will also enable you to control the assets and liabilities and protect your net worth, Read in Chapter 2 the collapse of some firms because of the manipulations made by the employees in connivance with the officers of the firm. ACCOUNTING INFORMATION ‘A year ot so after you have started operation, you need answers again to the following questions to determine the progress of the business. If plans are working well, you have to decide on what to do to make it more profitable. Or if performance falls out of expectation, changes have to be made. The six important questions are: 1) Was the business doing well, earning profit and an adequate return on my investment? 2) Was the business liquid, and able to pay obligations promptly on the due date? 3) Was the business solvent and able to withsand financial pressure? 4) How much money has come in and gone out? 5) Were the creditors (bank or supplier) paid on time? 6) Did I get good retirn (profit) on the money and other properties | invested? ‘A business owner and the other investors don’t want to be caught off guard. Time and again they would like to know what is happening to the business. Accounting provides financial ‘information regarding the business by preparing the following four financial reports which are called General Purpose Financial Statements: 1) Statement of Financial Position is a progress report showing a list of assets and liabilities. 2) Income Statement is a performance report of revenues against costs and expenses 3) Statement of Cash Flows is a cash report showing where we got and where we used the money. 4) Statement of Owner’s Net Worth is a progress report showing changes in wealth. If you want to become an accountant you need a thorough knowledge of all the aspects of accounting so you will be able to prepare the financial reports and be ready to interpret the results contained herein. If you are a statement user such as a lender, investor, customer, of manager then you need a working knowledge of accounting so you will understand the reports, evaluate them well and come up with good decisions. Keeping track of the revenues and expenses as well as the assets and liabilities is a basic procedure in accounting called Bookkeeping. This is the first phase of accounting which 4 Scanned with CamScannerinvolves gathering financial data and kee comprehensive than Bookkeeping. It involves th planning and controlling the various activities of HISTORY OF ACCOUNTING The earliest bookkeeping records were used to keep track of pyramids and palaces being constructed especially in Babylonia (present-day Iraq) and egypt. A record was kept of the number af slaves Who worked for Kings and Pharaols. They also tecorded the maferils used ead he number of days i ook forthe work to be finished, A regstty or record of people living in a town or city was also kept which became the basis for collecting taxes by the governor ota tone ce province. In the fifteenth century, records were also kept at the trading ports of Greece where the number of days spent for a trading Voyage was listed, together with the number and value of cargoes loaded and unloaded for a particular voyage, Servants were usually entrusted by their merchant-masters to keep track of their Properties (assets) and the debts (liabilities: ) they owed especially after a particular voyage, 2 a record of this. Accounting is more preparation of various financial reports for the business. ‘The first accounting book was written by Cotrugli in Naples and the modern double entry bookkeeping system could be traced from the book prepared in 1494 by an Italiag mathematician, Fr. Luca Pacioli, entitled Summa de Aritmeticn. In the Philippines, bookkeeping was introduced by the Spaniards and the bookkeeper ss called Tenedor de Libro. But even before the Spaniards came, trade was already flourishing between the Philippines and the other Asian countries and records of goods being bartered were kept by the traders, BUSINESS, ITS MOTIVE AND ROLE IN SOCIETY A business is an economic unit that engages in buying and selling of goods or services. ‘A major concern of a business is how best to use its resources: machines, raw materials, labor skills, number of men to employ. In a business endeavor, success is possible when money, machines, men and materials are used efficiently at the least possible cost. Most often success is measured in terms of profit and increase in funds When a person wants to put up his own business, the primary reason is to earn profit. Profit or income is obtained when the amounts received from customers and clients are higher than the cost of goods or services incurred or used up. Profit generates more resources or funds for the business. With more funds, the business can expand. You need more workers and this will create more job opportunities. Subsequently, more properties are acquired, more goods are produced and sold, and more taxes are paid to the government, Money received by the government from these taxes will help fund projects such as the construction of roads, bridges, and other infrastructures which facilitate transportation of people, B00ds and services. A flourishing business surely contributes to the ‘country’s economy. SOURCES OF CAPITAL You need money to start a business. The primary source of capital is the owner or investor. With a successful business, investor succeeds not only in getting back what was invested (return of capital) but receives more than the amount invested (return on capita). If the entrepreneur or investor does not have enough funids, a secondary source of capital is a telative, friend, bank or a cooperative. The micro finance programs (Tulay sa Pagunlad Ine, Bangko Kalayaan, BPI Globe Banko and the Rural Bank of the Philippines) help low-income Filipino entrepreneurs fund their projects. An entrepreneur is one who organizes, manages and takes the risk of putting up a business. It is, most often, synonymous to owner-manager. 5 Scanned with CamScannerMINIMIZING BUSINESS RISK ‘Any money making venture is risky. ‘The higher profit you desire, the more risky thy venture is. Risk is the clement of uncertainty in an outcome. An endeavor like a business h, always an clement of uncertainty- it is not certain that the operation of the business will tue ‘out well, nor is it certain that the owner will recover what was invested nor is it certain that the creditors will be paid. But there are ways of reducing risks such as: 1) careful planning and control of operation 2) making a business plan and carefully assessing the business you want to put up 3) having adequate knowledge about the product or service and 4) choosing the right form of business and the right type of operation. FORMS OF BUSINESSES t A business may be organized and take one of the following three legal forms: Sole Proprietorship This is a business set up and managed by one person, Most small businesses such as beauty parlors, dress shops, barbershops and bakeries are sole proprietor-owned. Advantages, a. Onlya small amount of capital is needed . Its operation can be managed easily by the proprietor. c. The owner or proprietor gets all the profits d. Ease in formation since only a minimum requirement to legally operate is needed, Disadvantages. Since there is only one owner/manager, it may be a. Difficult to expand the business and sell different products or services because of low capital and only one owiner-manager. b. _Ithasno indefinite life. Owner may just one day want to close it, or become incapacitated or die c. Owner has unlimited liabitity. It means that if the business is unable to pay its debt, the bank or creditor can attach the owner's personal properties Partnership This is a business owned by two or more persons called partners who contribute money, property and talent into a common fund for the purpose of sharing profit among themselves Most often the partners are also the managers. Professionals such as lawyers, accountanls, engineers and doctors usually put up a partnership or consultancy firm. Advantages a, Ease in managing the business and in attracting clients because of more owners involved b. Management is more efficient because of division of responsibilities among partners Disadvantages : a. No indefinite life since disagroements could easly arise because of many ownegs involved b. Partners, like sole proprietors, have unlimited liability. . Corporation A business organized as a separate legal entity from the owners. It means that it con ‘conduct business by itself - enter into contracts, buy and sell properties and stocks. aa investor buys shares of stocks and become a shareholder. It is managed by a Board of Directors elected by the shareholders from among themselves. Note'that Republic Act 11232 signed February 2019 revised some laws affecting corporate organization conduct such as its existence, pre-incorporation requirement, one-man corporation, ete. Scanned with CamScannerAdvantages. More capital can be raised be: Can afford to hire experts to Has perpetual existence. More stable than a Partnership as a sharcholder can sell his sharcholdings to others. Higher amounts of profit may be obtained because of its large resources. Allows a one-man corporation to be organized making it casy for small time entrepreneurs to enter the corporate playing field Disadvantages. a. Asharcholder, unlike a sole is therefore a higher risk inv of corporate funds b._ Itis subject to more legal and tax requirements, c. Abuse of power by the Board of Directors could certainly affect the welfare of the corporation and its shareholders. - TYPES OF BUSINESS OPERATION A business eams profit depending on its type of operation. There are at least three general lines of operation: ‘cause of the large number of buying sharcholders. efficiently manage and operate the business. meeece Proprietor or a partner, has no unlimited liability. There olved on corporate debts since these can dnly be paid out 1. Aservice business is one which provides servi beauty parlor, barbershop, travel agency, intemet shop, school, airline, Refer to Figure | 2-a Figure 1.2. Service Type of Business ce, for a fee, to clients or customers. Examples: 2. A merchandising business is one which buys and sells goods or merchandise Examples: shoe store, bookstore or a drugstore. Refer to Fig. 1.2 b. Figure 1.2b Merchandising Type of Business 7 Scanned with CamScanner3. A manufacturer is one who buys raw materials, processes these into finished goods and then ses these to customers. Examples: shoe factories, and food processors. Refer to Figure 1.2 Marikina shoemakers convert Icather into shoes, bags and slippers and sell these to Shoe Mart who is a retailer or merchandiser. ‘The retailer, in turn, sclls these to ultimate consumers. As compared to a merchandiser, the manufacturer would need a huge amoung of resources ot capital because of high fixed capital requirement- machines, tools, equipment, factory site and Jand. Figure 1.2 ¢ Manufacturing Type of Business WAYS OF OBTAINING PROFIT Figure 1.3 shows three ways of obtaining profit based on the type of operation. For the internet shop in Fig 1.2a profit of PS was obtained after it collected P15 from the customer for the use of the computer which cost the shop P10 per hour. For a bookstore in Fig 1.2b profit of P100 was obtained after it collected P250 from the customer for a book sold which cost the store P150. For the shoe shop, profit of P200 was obtained after it collected P500 for a pair of shoes which was manufactured at a total cost of P300 From each type of business, operating expenses must also be deducted next to obtain net income or net profit. BUSINESS CUSTOMER PROFIT Gives service Gives money Cost of using the computer. PIO. = ——> Service Revenue PIs Cost of service 10 Profit | Gives money Gives merchandise Cost of a book P1809. ———*. Sales Revenue 230 250 Cost of Sales 130 Gives money Profit P 100 Gives product Cost of leather P1s0 Sales Revenue 500 ‘Wage of shoemaker 100 Cost of Goods Sold 300 Factory utilities, repair, etc _S0 Profit P20 Cost of a pair of shoes Pigg >. tng eet Gives money Figure 1,3 Ways of Obtaining Profit Scanned with CamScannerResult of operation may show a profit, or a loss or just break-even: ‘)Profit ifreverues are] 2) Loss if revenues are | BrealeEven if revenues higher than cost and lower than costs and | are equal to costs and expenses __|__ expenses: expenses Revenues P 100,000 100,000 P100,000 Costs and 80,000 105,000 T 100,000 Expenses Net profit (net loss) P 20,000 © 5,000) 7 TYPES OF BUSINESS ACTIVITIES A business starts with financing activities. The owner “finances” the business with a start up capital in cash and other resources. If owner's contribution is insufficient, additional ing can be extended by banks and other financing institutions. Financing activities also include withdrawals (capital withdrawn) made by the owner/investor as well as loans repaid to lenders. As a business needs resources other than cash to be able to operate, it engages in investing activities such as the acquisition of properties in land, furniture, machineries and equipment. Eventually,these properties are disposed or retired on its maturity date. A business engages in operating activities related to earning of income by selling goods or services and by incurring expenses such as wages, rent, utilities, and transportation are paid. MANAGING THE BUSINESS The success of any business depends on many factors, one of which is good management. Management may be defined simply as getting things done by using resources and directing people as efficiently as possible to be able to accomplish the goals of the business. A manager has three objectives: a) that resources are being used productively, b) customers are satisfied with the product or service, and ©) business is generating adequate profit For a business to be successful, management must be efficient and effective. It is efficient if its resource inputs (materials and labor hours) are being used at the least time, effort and cost to produce the required output (products or services). Business is effective if it is able to attain its goals in terms of being able to, produce and sell the required number of products or services given a specific level of quality. Management involves four processes: planning, organizing, directing, and controlling a) Planning starts with determining the goals of the business and lining up activities to accomplish these goals. b) Organizing involves creating divisions, appointing managers, hiring and defining the roles or duties of each one (managers and staff). , © Directing means overseeing the daily operation of carrying out the planned activities ~ managers must act, decide, agree, argue, question, approve, solve. 4) Controlling means guarding and guiding people to ensure tasks and actvities are done according to plans and some standard of performance. Controlling prevents the commit of error or if detected then the error must be corrected and the product or service rewor i i keting, sales Managers are hired to head different'departments-production, finance, marl - and human resource, Production manager makes a study on what products to produce, how ‘0 produce these, what machines will be needed, how many workers will be hired, a. Scanned with CamScanner‘Then he draws a plan and direets the production activities accordingly. ‘The Marketin Menger ‘a Saab Wased cnia study &f the market- place, product, price, and people, Finance Manager takes care of the finanial resourees- how to source them (look i investors and creditors), and how to use them (purchase of capital assets, new produee payments of loans). The Sales Manager oversees selling operation- products, sales force anc customers, The Personnel Manager (akes care of employees and workers- selecting, training and overseeing them. hiring ACCOUNTING AS A BUSINESS LANGUAGE Accounting is defined as a service activity whose function is to prepare financial reports that will provide relevant information about the business. It is difficult for users ty make financial decisions that are not supported by facts. These facts are contained in the accounting reports. Accounting may also be defined as a process of recording, classifying and summarizing transactions and events which are financial in nature and interpreting the results thereof. Figure 1.4 below shows that Accounting is a bridge between the company and the interested parties or statement users, From the business activities which account accumulates, reports will be prepared and vital information communicated to the users, Accounting speaks in a language that users must understand, so that when they read the reports they will know what information itis trying to convey to the interested parties ne Stakeholders or Users Read the reports and make decisions SH Business Firms Accumulate financial data through its various activities Accountants. Process the financial data and prepares financial reports Figure 1.4 Accounting as a Language of Business USERS OF FINANCIAL INFORMATION Users of financial statements are called entity who'has a “stake” or interest in the busi other stakeholders are the customers, 10 stakeholders. A stakeholder is a person of iness. Aside from the owners or investors, the managers, lenders, suppliers, employees, goverment 04 Scanned with CamScannerThe one who puts in capital (such as money or property) in a business endeavor. To minimize risk of losing money, an owner or investor must read the financial reports and seck answers to the following questions: 1) Is the business profitable? 2) Does it give a fair return of profit on my investment? ‘Owner oF Investor ‘The one who is responsible for running the business, Financial reports Manager make it possible to evaluate performance of the business. 1) Are the plans being implemented beneficial to the business? 2) Is the business operating profitably? Remember a losing business depletes wealth and is a reflection of inefficient management. Lender or Creditor | A lender or creditor (example Banco de Oro) assesses the paying ability of the business-borrower by reading the financial reports: 1) Is the firm liquid paying its debt when it falls due? 2) Is the firm solvent having more assets than liabilities? - ‘A supplier (example Divisoria Textile Store) offers goods or Supplier merchandise on cash basis or on credit term. 1) If offered on credit, will the business who is buying merchandise (such as T Shirts) in bulk be able to pay its account on the date it becomes due? 2) Does it have liquid assets? The accounting information to determine the credit worth of the business is also based on its financial status. The government seeks to answer the following questions by reading the accounting reports: 1) Is the business paying the right taxes? 2) Is it filing all the required docurnents? ‘The government through its tax agent, the Bureau of Internal Revenue, investigates tax returns and assesses the truthfulness of the reported profit as well as the tax liability paid by the business. Government The employes wants: Employee a) higher wages b) benefits c) good working conditions and d) security of tenure The employees will assess the ability of the business to grant these demands through the financial reports. Remember, a losing business cannot afford to give higher salaries and more benefits. The customer assesses the company’s ability to continuously supply the goods they need at the right price and right quality. Customer The aforementioned stakcholders are classified as direct users and external users xcept for management who is an internal user. The indirect users are the stock exchange, le associations, regulatory bodies, and financial analysts who rely on the financial Statements in their role of regulating, assisting, advising and protecting clients and investors. il Scanned with CamScannerFigure 1.5 describes accounting as a service activity which provides financial information shown in the first column to statement users in support of various economic decisions shown in the third column. ACCOUNTING INFORMATION v Financial Information |—* Stakeholders lad Decisions Made i I Financing Decisions Laat” enter Investing Deion Solvency Managers Cash & Credit Strategies Cash Adequacy Suppliers Labor Relations Timing Employees Allocation of Resources Customers Tax Plans Government Figure 1.5 Accounting as Information Provider TYPES OF ACCOUNTING AREAS AND THE REPORTS PREPARED Go over page 4 again. Notice that all businesses, small or big, will be confronted wit managerial problems, the answers of which will need managerial reports. Go over pages 4 and 5, the answers to the questions regarding profit and solvency can be answered only with financial reports, Figure 1,6 on page 13 describes the channel where the different repors flow and mentions four accounting areas responsible for these reports: A. Intemal reports called managerial reports are prepared for management use. Although management receives the other reports they also require additional information such 2s Product cost, estimate of profit to be eamed for a planned project, comparison of two altemative courses of solving a problem, budgets, among others. This information need Bave rise to a course called Management Accounting. B. The main source of information of stakeholders or users are the financial reports or the so called general purpose financial statements, This information need gave rise to a course called Financial Accounting. These reports are audited by a Certified Public Accountant who atest to its fair presentation and validity making it reliable and acceptable by the stakeholders C. All firms are required to pay taxes to the Bureau of Internal Revenue (BIR). This information need gave rise to a course called Tax Accounting which specializes in the determination of taxes and preparation of various tax Teturns required to be filled up by taxpayers such as: Income Tax, VAT, and Percentage Tax D. Some firms, by the nature of their organization/operation, are required to prepare special reports by certain regulatory bodies. For example, banks prepare monthly, quarterly and annual reports to be submitted to Bangko Sentral ng Pilipinas. A business planner must submit to the Securities and Exchange Commission a Plan of Merger. Take note of the four accounting areas: Managerial, Financial, Tax and Government. Scanned with CamScannerManagement =a Managerial Reports Taxing ee REPORTING | | Special Regulatory Agencies (C) Reports PROCESS Reports (D) Agencies- such as BIR _ BSP, SEC Audited Financial Reports (B) Suppliers Lenders Investors Employees —" Customers oar Figure 1.6 Channels of Accounting Information ACCOUNTING INFORMATION SYSTEM Processing of transactions or activities to produce information must be done in an orderly and efficient manner. Accounting Information System (AIS) can be classified into two: “measurement system (processing phase) and the communication System (reporting and communicating phase). The processing phase involves analyzing, measuring, recording, classifying and summarizing, while the reporting phase involves the presentation of formal reports which are communicated to decision makers. Refer to Figure 1.6 in page 14 AIS Principles For the AIS to be effective and efficient, five principles must be followed, namely Control Principle, Cost-Benefit Principle, Relevance Principle, Compatibility Principle and Flexibility Principle. The Control Principle prescribes that the AIS of the firm must have good internal control. Internal Control enumerates the methods and procedures necessary to monitor the activities of the business and ensure efficient operation, With internal control, the following are achieved: 1) properties of the business are protected, 2) records are accurate and reliable, 3) company policies are complied with and 4) performance of business units or divisions are Properly evaluated, Internal control is a very significant feature of AIS. Internal control is discussed further in Chapter 14. Control procedures are described in the next two pages. Recall that to be efficient, the information must be timely and must be processed atthe least Gost and effort. And tobe effective, the information must be able to answer the needs of the decision makers. Supporting these requirements are two principles- Cost-Benefit Principle and the Relevance Principle. The Cost-Benefit Principle prescribes that the advantages enjoy' installing the system must outweigh its cost. For example, installing a computerized sysem may be costly but it can reduce the number of employees which in tum will reduce costs of s =. Scanned with CamScannerwages and allowances. Additionally, recording can be more accurate and lesser errors wil committed making the reports more reliable. ‘These and the fact that reports must always ¢° updated are considered benefits which would more than outweigh the cost of the installed s, Relevance Principle prescribes that the information must be reported promptly and information must be useful to cnable statement users to reach a conclusion and make a decision The Compatibility Principle prescribes a system designed to fit the unique characteristics OF the company- its personnel, activities and structure. A sole proprietor-owned business operating on! within a mall will Yequire a simple AIS. A multi-national company with diverse products and of shore operations will require a more complicated AIS. ‘The Flexibility Principle prescribes that the company's system should allow for changes, i change is needed to come up with timely and updated information in response to indu demand, government promulgations, technological advances and competitive pressures. Fo, cxample: multi-national companies have resorted to mergers and full consolidation reports, accounting policies have to be revised and the manner of preparing and presenting financial reports changed to suit the emerging new forms of business combinations. Components of an Accounting Information System A system, be it manual or computerized, involves people, documents, records, methods and equipment. These are the five components of an accounting information system. These will be discussed in line with the illustrated accounting informat‘on system shown in Figure 1.7, Note that in all four phases: people or personnel are involved from Phase 1 data gathering to Phase 4 summarizing, reporting and interpreting reports. Documents in support of the data are gathered in the first phase. All phases involve certain methods or procedures of doing. Equipment such as computers and printers are also needed in all phases to be able to process data and generate information which are then summarized in the form of financial reports. des «| | Seve classifying, reporting]! [ges | thering ' i ste -—>| . : a | | and recording ee a interpreting making PHASE | : PHASE 2 PHASE 3 PHASE 4 Figure 1.7, Accounting Information System Data processing starts with the gathering of documents which are evidences of business transactions. A transaction is an activity or event taking place in business which is expressed in terms of money. Examples: buying or selling of goods, receiving or paying cash, rendering or receiving service and borrowing or lending money. A business document describes in words and amounts the nature’ of the transaction. Examples: official receipt (when receiving cash), cash voucher (when paying cash) and invoice (when selling or buying goods of services). These documents come from various departments. The official receipt is prepared by the Collection Officer or Cashier from the Finance Department. The sales invoree iS prepared by the Sales Officer from the Sales Department, while the cash voucher is prepared by the Disbursing Officer from the Finance Department. Documents may be prepared manually or may be computer generated. Internal Control requires that documents be properly controlled, numbered and stored. Since the documents come from various departments, the personnel practically in the entire company are involved in preparing, gathering, handling and recording business transactions. Internal Control prescribes that only qualified people should be hired, thei’ 14 Scanned with CamScannerbe prepared only by the employ , yee duly assigned ti " duplication of functions by th 'y assigned to do such task. There should be no he employce to be able to pinpoint or fix responsibility. The documents are received by the Accounting Officer or Clerk. These are then analyzed, measured, recorded and classified, An input device or instrument is used to record the data captured in the documents, Ina manual system the pen or pencil is the input device. Ina computerized system the keyboard is the input device. The data input, be it manual oF ‘computerized, is called a journal entry e y- Other forms of input devices are the scanner and bar code readers (popularly used by groceries to ring up sales). Records are the books of accounts that must be maintained by the accounting department. Just as one gathers lecture notes and places them in a notebook, accounting data are gathered and recorded in a book called the journal, And since the recording will involve a large number of data too diverse to be understood by the decision-makers, to make it meaningful and understandable, the data is organized and classified into related groups and stored in another book called the I d the ledger. Phases 2 and 3 of the system cover the mechanical or procedural phase of accounting called Bookkeeping, Methods involve the procedures of Processing captured data from the documents. In accounting, information is processed in a meaningful manner by journalizing, classifying, summarizing, reporting, and interpreting. The processing can be done manually or electronically depending on the size of the organization, the volume of data to be processed, the amount of information required, and the need for prompt access to the data. The computerized system follows the same logic as the manual system although the processing is done differently. Finally, the organized data become meaningfal information when summarized and reported in the financial statements prepared by the accountant. The accountant further assists the decision-makers in making informed decisions by interpreting the financial data through a tool called financial statement analysis. COMPUTERS DO NOT REPLACE ACCOUNTANTS In an electronic data processing (EDP) environment, transactions may be recorded, classified and stored in a computer. When needed, information may be drawn out from the system using output devices such as the printer. Software is available to take care of the recording including the generation of documents and records and even the computations in the interpreting phase, The good news is that the electronic data processors have freed accountants from the routine aspects of processing data but computers cannot think, cannot evaluate or render judgment. Evaluation of the accounting information and the preparation of recommendations require the critical thinking and competence of the accountant and the decision makers. Figure 1.8 shows the computerized accounting system. INPUT PROCESS CUTPUT From the source ‘The data are measured, Reports come out documents, data are recorded, classified, from the processed analyzed and encoded summarized, and stored data by the employees. by the computer. Figure'J.8 Computerized Accounting System 15 Scanned with CamScanner208 contaii he business document and encod, The employce analyzes the data contained in tl I es data by using some software such as the Peach Tree, MYOB and Quick Books. he FINANCIAL REPORTS ILLUSTRATED As mentioned in the carly part of this chapter, there are four financial statements from which vital information can be extracted: a) Income Statement- shows how wealth is produced by listing the revenues earned any expenses incurred by the business. ; Statement of Owner's Equity- shows why the net worth changed by listing the activi that caused it to increase or decrease. c) Statement of Cash Flows- shows what happened to the cash by enumerating the Activities of cash received and cash used by the business. : 4) Statement of Financial Position- shows how the wealth of the busin enumerating the assets, liabilities and net worth of the business b) less stands by The financial reports are illustrated using’the business set up by Ms. Doria who ‘Opened a Xerox Service Center by investing on June 1 P200,000 out of her P300,000 pension. She also borrowed from UCPB another P200,000 for use in the business. With this she bought copying machine for P350,000, and supplies for P20,000. The remaining P30,000 she set aside for operating needs of the business. For June, she received P48,000 from the customers for reproduction work and paid P5,000 for rent and P3,000 for power and water. OF the supplies bought, 40% were used up. Figure 1.9 shows the financial statements: Income Statement (wealth produced) for June: Sales P 48,000 Supplies used ~ 20,000 x 40% ( 8,000) Rent (3,000) Power and Water (3.000) Profit for the month ending June 30, 2018 P 32,000 7 Statement of Changes in Equity (change in owner's wealth): | Doria Capital, June 1, 2018 200,000 Add Profit for the month 32,000 Doria Capital, June 30, 2018 232,000 Statement of Cash Flows Statement of Financial Position (change in cash ) for June: (wealth accumutated), June 30: Cash Investment, June 1 P200,000 -® Cash P-70,000 Cash borrowed from bank 200,000 | Supplies 12,000 Caan receipts from service sales 48,000 | Copying Machine 350,000 ‘ash paid for copying machine (350,000) | Total As 432,000 Cash paid for supplies (20,000) uses ioe Cash paid for rent ( 5,000) | Loan Payable 200,000 faa paid for power and water (3,000) Doria, Capital 232,000 ish balance, June 30 P 70,000. Total Liabilities and Owner's 432,000 Equity Figure 1.9 Financial Reports of Copying Service Center Scanned with CamScanneried general purpose financial statements, The arrows show the interrelationships of the finarel reports. Note that the ending capital balance and the ending cash balance ate transferred te he statement of financial position where all the accumulated i assots and liabilities are presented. From a starting capital of P200,000, Doria’s capital became P232,000 at the end of June, Profie enhances the wealth come shows how the scarce resource (P200,000 cash used in business to make it profitabl rN le (P32,000) and enhance wealth of owner (P232,000). Income Statement reports the financial performance of the business and is also called profit or loss statement or statement of earnings, It lists down the income (reven ves and gains) cared as well as the expenses i Statement of Changes in Owner’s Equity is another report prepared by the accountant which explains the activites for a period of time that caused the owner's equity to change investment, withdrawal or recovery of lecrease owner’s equity. If the beginning capital is F200,000 what caused it to change or increase to P232,000? This is explained by adéing profit to capital in the statement of changes in owner's equity. What if profit i¢ 32,000 but the ending capital became P230,000? Then there must be another item that caused itto change or decrease and the only possible answer is that the owner may have \withdrawn cash or supplies amounting to P2,000 during the month, This will also decrease the assets of the enterprise by the same amount either in cash or supplies, The Statement of Cash Flows shows what caused the change in the cash. It answers the question: the business started with P200,000 cash, how come after one mont! 270,000? The statement shows the cash inflows (investment and sales) and outflows (purchase of machine and payment of expenses). Since oulflows are higher than the inflows, the cash lecrease( "70,000. This statement shows three kinds of activities: financing (investment of the owner and cash loan), investing (acquisition and sale of properties) and operating (revenues and expenses) th it is just Statement of Financial Position (formerly called the balance sheet) shows how healthy poe bust the enterprise is when it shows a listing of the accumulated resources (gash and Moperties) owned and a listing of the accumulated liabilities (debts or obligations to pay) owed by the enterprise. After deducting the libiltics from the assets, the net asses show the net value of mWorth ofthe firm which belongs to the owner. Hence itis also called the owner's equity. The Howth of June showed a listing of P432,000 assets while liabilities amounted to P200.000. The ness net worth or assets belonging to the owner is only P232,000. The statement shows a financial structure since liabilities and owner’s equity are more~or less the same in “mount. This statement also shows whether the enterprise is solvent (enough assets to take care of all obligations) and liquid (ability of the enterprise to pay promptly for obligations that are due). 17 Scanned with CamScannerawNe Oe 23. 24. 25. 26. 27. 28. 29, Since Doria contributed only P200,000, the resources of the bi Some rules guide the practice of accounting and will be discuss . What is the main difference between a merc! + Give examples of business . Explain the role of the different . Fora business to be sucessful, - When is revenue recogii . Explain unlimited liabil - Define accounting. What isits basic purpo |. Why is accounting Why was Doria’s remaining pension of 100,000 not included in the above Statements) usiness start from this amos ed in Chapters 3 and 4, GUIDE QUESTIONS As user of accounting infor mation, explain how accounting affects your Personal life, Aside from profit, what are the other reasons why a person goes into business? Explain why business plays an important role in the economy of the country. Enumerate the different resources needed to run a business, How should these resource, bbe handled in order for the business to be successful? ‘What are the two sources of business funding or financing? / ‘Why is investing in business always risky? How do we minimize the risk? How is the success of a business measured? . What is profit, how is it eamed and what is its effect on business? . Discuss the forms of business that may be organized. Give the advantages ang disadvantages of each, handising business and a manufacturing business) firms operating as service providers, merchandisers, q manufacturers. Differentiate retum on investment from return of investment, departmental managers in a business organization, management must be efficient and effective Explain what these mean. Describe the four functions of management. Give the format in computing for the profit of a service business, a merchandising business and a manufacturing business, Zed by a service provider? By a merchandiser? By a manufacturer ity. Will all investors be affected by this? se? Ts bookk ‘eeping and accounting the same? called the language of business? ’ services being sold What was its initial capital requirement and present net wont Aside from profit, what are the other reasons for Putting up the business, Who are its major customers and competitors What are the current problems confronting the business, ‘What 1s accounting information system (AIS)? Give the four phases of an accounting information system, Explain the four types of reports that are gencrated by the accounting information system Discuss the components of an AIS, Give examples of intemal control p rocedures a business e1 Give the advantages of a computer ‘nterprise must implement. based over a manual-based accounting system. Scanned with CamScanner