Overview of Accounting

Overview of Accounting
Learning Objectives
1. Define accounting and state its basic purpose.
2. Explain the basic concepts applied in accounting.
3. State the branches of accounting and the sectors in the practice
of accountancy.
4. 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 judgments and decisions by users of the information." - (American
Association of Accountants)
Three important activities included in the definition of accounting
1. Identifying
2. Measuring
3. Communicating
Identifying
Identifying is the process of analyzing events and transactions to determine whether or not they
will be recognized.
> Recognition refers to the process of including the effects of an accountable event in the
statement of financial position or the statement of comprehensive income through a journal
entry.
Only accountable events are recognized (i.e., journalized). An accountable event is one that
affects the assets, liabilities, equity, income or expenses of an entity. It is also known as
economic activity, which is the subject matter of accounting. Only economic activities are
emphasized and recognized in accounting. Sociological and psychological matters are not
recognized.
Non-accountable events are not recognized but disclosed only in the notes, if they have
accounting relevance. Disclosure only in the notes is not an application of the recognition
process. A non-accountable event that has an accounting relevance may be recorded through a
memorandum entry.
Types of events or transactions
1. External events - are events that involve an entity and another external party.
Types of External events
i. Exchange (reciprocal transfer) - an event wherein there is a reciprocal giving and receiving of
economic resources or discharging of economic obligations between an entity and an external
party.
 Examples: sale, purchase, payment of liabilities, receipt of notes receivable in exchange for
accounts receivable, and the like.
ii. Non-reciprocal transfer - is a "one way" transaction in that the party giving something does
not receive anything in return while the party receiving does not give anything in exchange.
Examples: donations, gifts or charitable contributions, payment of taxes, imposition of fines,
theft, provision of capital by owners, distributions to owners', and the like. 1 FASB
Accounting Standards Codification (ASC) 845
iii. 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.
Examples: changes in fair values and price levels, obsolescence, technological changes,
vandalism, and the like.
2. Internal events are events that do not involve an external
party.
Types of Internal events are
i. Production the process by which resources transformed into finished goods. Examples:
conversion of raw materials into finished products, production of farm products, and the like.
ii. Casualty - an unanticipated loss from disasters or other similar events. Examples: loss from
fire, flood, and other catastrophes.
Measuring
Measuring involves assigning numbers, normally in monetary terms, to the economic
transactions and events.
Several measurement bases are used in accounting which include, but not limited to, historical
cost, fair value, present value, realizable value, current cost, and sometimes inflation- adjusted
costs. The most commonly used is historical cost. This is with the other measurement bases.
usually combined Accordingly, financial statements are said to be prepared using a mixture of
costs and values. Costs include historical cost and current cost while values include the other
measurement bases.
Valuation by fact or opinion
The use of estimates is essential in providing relevant information. Thus, financial statements
are said to be a mixture of fact and
opinion.
When measurement is affected by estimates, the items measured are said to be valued by
opinion. Examples:
a. Estimated liabilities, such as provisions.
d. Retained earnings, which is affected by various estimates of income and expenses
When measurement is unaffected by estimates, the items measured are said to be valued by
fact. Examples: a. Ordinary share capital valued at par value b. Land stated at acquisition cost
C. Cash measured at face amount
Communicating
Communicating is the process of transforming economic data into useful accounting
information, such as financial statements and other accounting reports, for dissemination to
users. It also involves interpreting the significance of the processed information.
The communicating process of accounting involves three aspects: 1. Recording refers to the
process of systematically committing into writing the identified and measured accountable
events in the journal through journal entries.
2. Classifying involves the grouping of similar and interrelated items into their respective classes
through postings in the ledger.
3. Summarizing - putting together or expressing in condensed form the recorded and classified
transactions and events. This includes the preparation of financial statements and other
accounting reports.
Interpreting the processed information involves the computation of financial statement ratios.
Some regulatory bodies, such as the Bangko Sentral ng Pilipinas (BSP), require certain
financial ratios to be disclosed in the notes to financial ratio. disclosed in the notes to financial
statements.
The basic purpose of accounting is to provide information that is useful in making economic
decisions.
Various sources of information are used when making economic decisions and the financial
statements are only one of those sources. Other sources may include current events, industry
publications, internet resources, professional advices, expert systems, etc.
Economic entities use accounting to record economic activities, process data, and disseminate
information intended to be useful in making economic decisions.
An economic entity is a separately identifiable combination of persons and property that uses or
controls economic resources to achieve certain goals or objectives. An economic entity may
either be a:
a. Not-for-profit entity - one that carries out some socially desirable needs of the community or
its members and whose activities are not directed towards making profit; or
b. Business entity - one that operates primarily for profit.
Economic activities are activities that affect the economic resources (assets) and obligations
(liabilities), and consequently, the equity of an economic entity. Economic activities include: 1.
Production - the process of converting economic resources into outputs of goods and services
that are intended to have greater utility than the required inputs.
2. Exchange - the process of trading resources or obligations for other resources or obligations.
3. Consumption the process of using the final output of the production process.
4. Income distribution - the process of allocating rights to the use of output among individuals
and groups in society.
5. Savings - the process of setting aside rights to present consumption in exchange for rights to
future consumption. 6. Investment the process of using current inputs to increase the stock of
resources available for output as opposed to immediately consumable output.

6 Types of information provided by accounting

1. Quantitative information - information expressed in numbers, quantities, or units.
2. Qualitative information - information expressed in words or descriptive form. Qualitative
information is found in the notes to financial statements as well as on the face of the other
financial statements.
3. Financial information - information expressed in money. Financial information is also
quantitative information because monetary amounts are normally expressed in numbers.
Types of accounting information classified as to users' needs
1. General purpose accounting information designed to meet the common needs of most
statement users. This information is provided under financial accounting. General purpose
information is governed by generally accepted accounting principles (GAAP) represented by the
Philippine Financial Reporting Standards (PFRSs).
2. Special purpose accounting information - designed to meet the specific needs of particular
statement users. This information is provided by other types of accounting other than financial
accounting, e.g., managerial accounting, tax basis accounting.
Sources of information in financial statements
Information in the financial statements is not obtained exclusively from the entity's accounting
records. Some are obtained from external sources. For example, fair value measurements,
resolutions of uncertainties, future lease payments, and contractual commitments are only a few
of the information presented in the financial statements that are derived from external sources
Accounting as science and art
1. As a social science, accounting is a body of knowledge which has been systematically
gathered, classified and organized.
2. As a practical art, accounting requires the use of creative skills and judgment.
Accounting as an information system
Accounting identifies and measures economic activities, processes information into financial
reports, and communicates these reports to decision makers.
Accounting as a language of business
 Accounting is often referred to as a "language of business" because it is fundamental to the
communication of financial information.
Creative and Critical thinking in accounting
The practice of accountancy requires the exercise of creative and critical thinking
a. Creative thinking involves the use of imagination and insight to solve problems by finding
new relationships (ideas) among items of information. It is most important in identifying
alternative solutions.
b. Critical thinking involves the logical analysis of issues, using inductive or deductive
reasoning to test new relationships to determine their effectiveness. It is most important in
evaluating alternative solutions.
Creative skills and judgment are exercised in problem solving. The following are the steps in
problem solving:
1. Recognizing a problem
2. Identifying alternative solutions
3. Evaluating the alternatives
4. Selecting a solution from among the alternatives
5. Implementing the solution
Accounting Concepts
Accounting concepts refer to the principles upon which the process of accounting is based.
The term "accounting concepts" is used interchangeably with the following terms:
- are the Accounting assumptions (Accounting postulates) fundamental concepts or
principles and basic notions that provide the foundation of the accounting process.
Accounting theory - is logical reasoning in the form of a set of broad principles that (i)
provide a general frame of reference by which accounting practice can be evaluated and (ii)
guide the development of new practices and procedures. It is the organized set of concepts
and related principles that explain and guide the accountant's action in identifying,
measuring, communicating accounting information. Accounting theory comprises the
Conceptual Framework and the Philippine Financial Reporting Standards (PFRSs).
Most accounting concepts are derived from the Conceptual Framework and the Philippine
Financial Reporting Standards (PFRSs). However, some accounting concepts are implicit,
meaning they are not expressly stated in the Framework or PFRSS but are generally
accepted because of their long-time use in the profession
Examples of accounting concepts:
1. Double-entry system - each accountable event is recorded in two parts - debit and
credit.
2. Going concern assumption - the entity is assumed to carry on its operations for an
indefinite period of time. Meaning, the entity does not expect to end its operations in the
foreseeable future.
The measurement basis involving mixture of costs and values is appropriate only when the
entity is a going concern. If the entity is a liquidating concern, the appropriate measurement
basis is realizable value, i.e., estimated selling price less estimated costs to sell for assets and
expected settlement amount for liabilities.
3. Separate entity (Accounting entity / Business entity concept! Entity concept) -the entity is
viewed separately from its owners. Accordingly, the personal transactions of the owners among
themselves or with other entities are not recorded in the entity's accounting records. This
concept defines the area of interest of the accountant.
4. Stable monetary unit (Monetary unit assumption)
a. Assets, liabilities, equity, income and expenses are stated in terms of a common unit of
measure, which is the peso in the Philippines; and
b. The purchasing power of the peso is regarded as stable or constant and that its instability is
insignificant and therefore ignored.
*To be useful, accounting information should be stated in a common denominator. For example,
amounts in foreign currencies should be translated into pesos.
5. Time Period (Periodicity/ Accounting period) the life of the entity is divided into series of
reporting periods. An accounting period is usually 12 months and may either be a calendar year
or a fiscal year period. A calendar year period starts on January 1 and ends on December 31 of
that same year. A fiscal year period also covers 12 months but starts on a date other than
January, 1.
6. Materiality concept - information is material if its omission or misstatement could influence
economic decisions. Materiality is a matter of professional judgment and is based on the size
and nature of the item being judged.
7. Cost-benefit (Cost constraint/ Reasonable assurance) - the cost of processing and
communicating information should not exceed the benefits to be derived from it.
8. Accrual Basis of accounting - the effects of transactions and other events are recognized
when they occur (and not as cash is received or paid) and they are recorded in the accounting
records and reported in the financial statements of the periods to which they relate.
Under accrual basis, income is recognized when earned rather than when cash is collected and
expenses are recognized when incurred rather than when cash is paid.
9. Historical cost concept (Cost principle) - the value of an asset is determined on the basis of
acquisition cost.
This concept is not always maintained. Some PFRSS require the departure from this concept,
such as when inventories are measured at net realizable value (NRV) rather than at cost when
applying the "lower of cost and NRV"
measurement.
10. Concept of Articulation - all of the components of a complete set of financial statements are
interrelated. The preparation of a worksheet (and the eventual completion of the financial
statements) recognizes that the financial statements are fundamentally interrelated and interact
with each other. Accordingly, when users use the financial statements in making decisions, they
need to use each financial statement in conjunction with the other financial statements.
For example, when evaluating an entity's ability to generate future cash flows, all the financial
statements should be used and not only the statement of cash flows.
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Receivables and payables in the statement of financial position provide information on expected
cash receipts and cash disbursements in future periods.
Income and expenses in the statement of profit or loss and other comprehensive income
provide information on the entity's ability to generate cash flows from its operations.
Information on issued and unissued shares in the statement of changes in equity provides
information on the availability of equity financing.
Information on historical changes in cash and cash equivalents in the statement of cash flows
helps users assess future sources and uses of funds.
The notes to financial statements provides information on the quality of earnings, e.g., whether
income or expenses are realized or unrealized or whether they are recurring or non-recurring.
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11. Full disclosure principle this principle recognizes that the nature and amount of information
included in the financial statements reflect a series of judgmental trade-offs. The trade- offs
strive for:
a.
sufficient detail to disclose matters that make a difference to users, yet
b. sufficient condensation to make the information understandable, keeping in mind the costs of
preparing and using it.
12. Consistency concept - the financial statements are prepared on the basis of accounting
principles that are applied consistently from one period to the next. Changes in accounting
policies are made only when required or permitted by the PFRSS or when the change results to
more relevant and reliable information. Changes in accounting policies are disclosed in the
notes.
13. Matching (Association of cause and effect) - costs are recognized as expenses when the
related revenue is recognized.
14. Entity theory - the accounting objective is geared towards proper income determination.
Proper matching of costs against revenues is the ultimate end. This theory emphasizes the
income statement and is exemplified by the equation "Assets Liabilities + Capital."
1
15. Proprietary theory the accounting objective is geared towards the proper valuation of assets.
This theory emphasizes the importance of the balance sheet and is exemplified by the equation
"Assets - Liabilities = Capital."
16. Residual equity theory - this theory is applicable when there are two classes of shares
issued, i.e., ordinary and preferred. The equation is "Assets Liabilities - Preferred Shareholders'
Equity Ordinary Shareholders' Equity." This theory is applied in the computation of book value
per share and return on equity.
17. Fund theory - the accounting objective is neither proper income determination nor proper
valuation of assets but the custody and administration of funds. The objective is directed
towards cash flows, exemplified by the formula "cash inflows minus cash outflows equals fund."
This concept is used in government accounting and fiduciary accounting.
18. Realization - the process of converting non-cash assets into cash or claims for cash. It is
also the concept that deals with revenue recognition.
For example, realization occurs when goods are sold for cash or in exchange for accounts
receivable or notes receivable. The goods are non-cash assets and they are converted into
cash or, in the case of the receivables, claims for cash.
19. Prudence (Conservatism) - is the use of caution when making
estimates under conditions of uncertainty, such that assets or income are not overstated and
liabilities or expenses are not understated. In other words, when exercising prudence, the one
which has the least effect on e least effect on equity is chosen.
However, the exercise of prudence does not allow the deliberate understatement of assets or
overstatement of liabilities in order to create hidden reserves because the financial statements
would not be faithfully represented.
An example of a hidden reserve is the "cookie jar reserve." It is a form of fraudulent reporting
wherein during periods of high profits, liabilities are overstated through excessive provisions of
expenses or non-recognition of income. In subsequent periods, when the entity's financial
performance is poor, the "cookie jar reserve" is reversed to income in order to report high
profits. Management engages in such fraud because of various reasons, which may include
smoothing earnings in order to secure bonuses over time, defer profits to the periods when they
are evaluated for promotion or for election as members of the board of directors, or to show
profits when other entities belonging to the same industry show declining financial performance.
Expense recognition principles
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20. Matching concept (Direct association of costs and revenues) costs that are directly related
to the earning of revenue are recognized as expenses in the same period the related revenue is
recognized.
For example, the cost of inventory is initially recognized as asset and recognized as expense
(i.e., cost of sales) when the inventory is sold. Other examples include freight-out and sales
commissions; these are expensed in the period the related sales are recognized.
21. Systematic and rational allocation - costs that are not directly related to the earning of
revenue are initially recognized as assets and recognized as expenses over the periods their
economic benefits are consumed, using some method of allocation.
For example, the cost of equipment is initially recognized as asset and subsequently recognized
as depreciation expense over the periods the equipment is used Other examples include
amortization, expensing of prepayments, and effective interest method of allocation.
22. Immediate recognition - costs that do not meet the definition of an asset, or ceases to meet
the definition of an asset, are expensed immediately. Examples include casualty losses and
impairment losses.
Common branches of accounting
1. Financial accounting - is the branch of accounting that focuses on general purpose financial
statements.

➤ General purpose financial statements are those statements that cater to the common needs
of external users, primarily the potential and existing investors, and lenders and other creditors.
External users are those who are not involved in managing the entity.

➤ Financial accounting is governed by the Philippine Financial Reporting Standards (PFRSS).

Financial accounting vs. Financial reporting The term "financial accounting" is often used
interchangeably with the term "financial reporting." Although, both financial accounting and
financial reporting focus on general purpose financial statements, the latter endeavors to
promote principles that are also useful in "other financial reporting."
"Other financial reporting" comprises information provided outside the financial statements that
assists in the interpretation of a complete set of financial statements or improves users' ability to
make efficient economic decisions.
Financial statements vs. Financial report
> Financial statements are the structured representation of an entity's financial position and
results of its operations. They are the end product of the accounting process and the means by
which information gathered and processed are periodically y communicated to users.

➤ A financial report includes the financial statements plus other information provided outside
the financial statements that assists in the interpretation of a complete set of financial
statements or improves users' ability to make efficient economic decisions.

Financial reporting is the provision of financial information about an entity that is useful to
external users, primarily the investors, lenders, and other creditors, in making investment and
credit decisions.
Primary objective of financial reporting
To provide information about an entity's economic resources, claims to those resources, and
changes in those resources.
Secondary objective of financial reporting
To provide information useful in assessing the entity's management stewardship (i.e., how
efficiently and effectively the entity's management has discharged its responsibilities to use the
entity's economic resources).
2. Management accounting - refers to the accumulation and communication of information for
use by internal users or management. An offshoot of management accounting is management
advisory services which includes services to clients on matters of accounting, finance, business
policies, organization procedures, product costs, distribution, and many other phases of
business conduct and operations.
3. Cost accounting - is the systematic recording and analysis of the costs of materials, labor,
and overhead incident to production.
4. Auditing is the process of evaluating the correspondence of certain assertions with
established criteria and expressing an opinion thereon.
5.
Tax accounting the preparation of tax returns and rendering of tax advice, such as the
determination of the tax consequences of certain proposed business endeavors.
6. 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..
7. Fiduciary accounting - refers to the handling of accounts managed by a person entrusted with
the custody and management of property for the benefit of another.
8. Estate accounting - refers to the handling of accounts for fiduciaries who wind up the affairs
of a deceased person.
9. Social accounting (social and environmental accounting or social responsibility reporting) -
the process of communicating the social and environmental effects of an entity's economic
actions to the society

10. Institutional accounting - the accounting for non-profit entities other than the government.
11. Accounting systems - the installation of accounting procedures for the accumulation of
financial data and designing of accounting forms to be used in data gathering.
12. Accounting research - pertains to the careful analysis of economic events and other
variables to understand their impact on decisions. Accounting research includes a broad range
of topics, which may be related to one or more of the other branches of accounting, the
economy as a whole, or the market environment.
Bookkeeping and Accounting
Bookkeeping refers to the process of recording the accounts or transactions of an entity.
Bookkeeping normally ends with the preparation of the trial balance. Unlike accounting,
bookkeeping does not require the interpretation of the significance of the processed information.
Accountancy
Accountancy refers to the profession or practice of accounting. The practice of accounting can
be broadly classified into two - (1) Public practice and (2) Private practice. Public practice does
not involve an employer-employee relationship while private practice involves an employer-
employee relationship, meaning the accountant is an employee.
Four sectors in the practice of accountancy
Under R.A. 9298 also known as the "Philippine Accountancy Act of 2004," the practice of
accounting is sub-classified into the following:
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 certified public
accountant.
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.
those
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, including performing proprietary functions, where decision making requires
professional knowledge in the science of accounting, or where civil service eligibility as a
certified public accountant is a prerequisite.
Accountants practicing under numbers 2 to 4 above are considered in private practice.
Accounting standards
The Philippine Financial Reporting Standards (PFRSs) represent the generally accepted
accounting principles (GAAP) in the Philippines.
The PFRSS are Standards and Interpretations adopted by the Financial Reporting
Standards Council (FRSC). They comprise: Philippine Financial Reporting Standards
(PFRSS);
a. Philippine Financial Reporting Standard (PFRSs)
b. Philippine Accounting Standards (PASS); and
c. Interpretations
PFRSS are accompanied by guidance to assist entities in applying their requirements. A
guidance state whether it is an