chapter one:
accounting in action
accounting activities and users
Accounting
•
•
•
the financial information system that provides insights on how to understand what is happening
financially inside an organization
its origins are generally attributed to the work of Luca Pacioli
o Italian Renaissance mathematician
o close friend and tutor to Leonardo da Vinci
o contemporary of Christopher Columbus
Summa de Arithmetica, Geometria, Proportione et Proportionalite (1994)
o described a system to ensure that financial information was recorded efficiently and
accurately
Accounting Activities
1. Identify economic events relevant to the business.
2. Record the events in order to provide a history of its financial activities
o Recording: consists of keeping a systematic, chronological diary of events (measured in
monetary units).
▪ classifies and summarizes economic events
3. Communicate the collected information to interested users by means of accounting reports.
o e.g., financial statements
o report the recorded data in a standardized way
▪ accumulates information resulting from similar transactions
• collected in the aggregate
o accounting process simplifies a multitude of transactions and
makes a series of activities understandable and meaningful
 Vital Element: ability to analyze and interpret the reported information
1. Analysis: involves use of ratios, percentages, and charts to highlight significant
financial trends and relationships.
2. Interpretation: involves explaining the uses, meaning, and limitations of reported
data.
 Bookkeeping: involves only the recording of economic events
Identification
Recording
Select economic events
(transactions).
Record, classify, and
summarize.
Communication
1. Prepare accounting reports
2. Analyze and interpret
results for users
Users of Accounting Information
1. Internal Users: managers who plan, organize, or run the business.
• e.g., marketing managers, production supervisors, finance directors, and company officers
 Managerial Accounting
• provides internal reports to help users make decisions about their companies
o financial comparisons of operating alternatives
o projection of income from new sales campaign
o forecasts of cash needs for next year
• provides detailed information on a timely basis
2. External Users: individuals and organizations outside a company who want financial information
about the company
o most common types: investors and creditors
a. Investors (Owners)
o use accounting information to decide whether to buy, hold, or sell ownership shares of a
company
b. Creditors (Suppliers/Bankers)
o use accounting information to evaluate the risks of granting credit or lending money
c. Taxing Authorities
o want to know whether the company complies with tax laws
d. Regulatory Agencies
o want to know whether the company is operating within prescribed rules
e. Customers
o interested in whether a company will continue to honor product warranties and support
its product line
f. Labor Unions
o want to know whether companies have the ability to pay increased wages and benefits to
union members
 Financial Accounting
• provides economic and financial information for investors, creditors, and other external users
building blocks of accounting
Ethics in Financial Reporting
A. Ethics
• standards of conduct by which actions are judged as right or wrong, honest or dishonest, fair or
unfair
 Effective financial reporting depends on sound ethical behavior.
B. Steps in Analyzing Ethics Cases and Situations
1. Recognize an ethical situation and the ethical issues involved.
o use personal ethics to identify ethical situation and issues
o businesses and organizations: written codes of ethics as a guide in business
situations
2. Identify and analyze the principal elements in the situation.
o identify the stakeholders
▪ people or groups who may be harmed or benefited
o ask what are the responsibilities and obligations of the parties involved
3. Identify the alternatives and weigh the impact of each alternative on various stakeholders.
o select the most ethical alternative
▪ consider all the consequences
o evaluate each solution and select the best alternative
Accounting Standards
A. Accounting Standard-Setting Bodies
1. International Accounting Standards Board (IASB)
o headquartered in London
o 15 board members from around the world
2. Financial Accounting Standards Board (FASB)
3. International Financial Reporting Standards (IFRS)
o standards determined by IASB
o followed by more than 130 countries
4. Generally Accepted Accounting Principles (GAAP)
o standards issued by FASB
o used by most companies in US
 Convergence: effort made by the two-setting bodies to reduce the differences between IFRS and
U.S. GAAP
Measurement Principles
Selection of which principle to follow generally relates to trade-offs between relevance and faithful
representation:
 Relevance: financial information is capable of making a difference in a decision
 Faithful Representation: the numbers and descriptions match what really existed or
happened (factual)
A. Historical Cost Principle (or Cost Principle)
• dictates that companies record assets at their cost
▪ true at the time the asset is purchased and over the time the asset is held
• e.g., Land Purchased for PHP90,000
o even if its fair value increased to PHP 100,000, it would continue to report the land at
PHP 90,000
B. Fair Value Principle
• states that the assets and liabilities should be reported at fair value
o Fair Value: the price received to sell an asset or a liability
• fair value information may be more useful than historical cost for certain types of assets and
liabilities
• only applied extensively in situations where assets are actively traded (e.g., investment securities)
Assumptions
•
provide a foundation for the accounting process
A. Monetary Unit Assumption
• requires that companies include in the accounting records only transaction data that can be
expressed in money terms
• enables accounting to quantify (measure) economic events
• vital to applying the historical cost principle
• prevents the inclusion of some relevant information in the accounting records
o employee’s morale
o quality of service
o owner’s health
B. Economic Entity Principle
• requires that the activities of the entity be kept separate and distinct from the activities of its
owners and all other economic entities
 Economic entity: can be any organization or unit in society
1. Proprietorship
o business owned by one person
o owner = manager/operator of the business
▪ receives any profit
▪ suffers any losses
▪ personally liable for all the debts of the business
o relatively small amount of capital is needed
o no legal distinction between the owner and the business
▪ personal and accounting records should be kept separate
2. Partnership
o business owned by two or more persons (partners)
o partnership = proprietorship; except that more than 1 owner is involved
▪ each partner = unlimited liability
o partnership transactions must be kept separate from personal records
 Partnership Agreement
o sets forth such terms as:
a) initial investment
b) duties of each partner
c) division of net income/loss
d) settlement to be paid upon death or withdrawal of a partner
3. Corporation
o business organized as a separate legal entity under jurisdiction corporation law and
having ownership divided into transferable shares
o enjoys an unlimited life
▪ ownership can be transferred without the organization being dissolved
o shareholders: holders of the shares
▪ enjoy limited liability
• not personally liable for the debts of the corporate entity
▪ may transfer all or part of their ownership shares to other investors at any time
• sell their shares
the accounting equation
Two Basic Elements of a Business
•
what it owns and what it owes
1. Assets
• the resources a business owns
2. Liabilities
• claims of those to whom the company owes money (creditors)
3. Owner’s Equity
• claims of owners
Basic Accounting Equation
Assets = Liabilities + Owner’s Equity
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•
•
liabilities appear first before the equity because they are paid first if a business is liquidated
applies to all economic entities regardless of size, nature, and form
provides the underlying framework for recording and summarizing economic events
Assets
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resources a business owns
used in carrying out activities such as production and sales
has the capacity to provide future services or benefits (common characteristic)
o service potential or future economic benefit → cash inflow (or receipts)
either claimed by creditors (liabilities) or owners (equity)
Liabilities
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•
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claims against assets
existing debts and obligations
businesses: usually borrow money and purchase merchandise on credit
o these economic activities → payables:
1. Accounts Payable
▪ purchasing assets on credit
2. Note Payable
▪ bank debts
3. Salaries and Wages Payable
4. Sales and Real Estate Taxes Payable
 Creditors: persons or entities to whom a business owes money
o may legally force the liquidation of a business that does not pay its debt
o law requires that the creditor claims be paid before ownership claims
Owner’s Equity
•
claim on total assets
o total assets – creditor claims = ownership claims
• often referred to as residual equity
o creditor claims are to be paid before ownership claims
A. Increases in Owner’s Equity
1. Investments by Owner
o the assets that the owner puts into the business
o recorded in the category called the “owner’s capital”
2. Revenues
o gross increase in owner’s equity resulting from business activities entered into for the
purpose of earning income
o generally result from:
▪ selling merchandise
▪ performing services
▪ renting property
▪ lending money
o sources of revenue:
▪ sales
▪ interest
▪ fees
▪ dividends
▪ services
▪ royalties
▪ commissions
▪ rent
B. Decreases in Owner’s Equity
1. Drawings
o withdrawal of cash or assets for personal use
o used to determine the total withdrawals for each accounting period
o recorded in the category called “owner’s drawing”
2. Expenses
o cost of assets consumed, or services used in the process of earning revenue
o
decreases in owner’s equity that result from operating the business
Owner’s Equity
Revenue (+)
Expenses (–)
Owner’s Capital (+) Owner’s Drawings (–)
Expanding Accounting Equation
Assets
=
Liabilities
+
Owner’s
Capital
–
Owner’s
Drawings
+
Revenues
–
Expenses
analyzing business transactions
Accounting Information System
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the system of collecting and processing transaction data and communicating financial
information to decision makers
rely on the accounting cycle
o begins with analyzing business transactions
o ends with the preparation of post-closing trial balance
 Factors that Shape an AIS:
o nature of the business
o types of transaction
o size of the company
o volume of data
o information demands of management
 Electronic Data Processing Systems (EDP)
o computerized accounting system
o handle all the steps involved in the recording process
▪ initial data entry to preparation of financial statements
Accounting Transactions
A. Transactions (Business Transactions)
• business's economic events recorded by accountants
1.
External Transactions
o involve economic events between the company and some outside enterprise
2. Internal Transactions
o economic events that occur entirely within one company
 Events → Is the financial position of the company changed? → Yes (Record) or No (Do not Record)
 Each transaction must have a dual effect in the accounting equation
o when asset is increased, there will be a/n:
▪ decrease in another asset
▪ increase in a specific liability
▪ increase in owner’s equity
B. Summary of Transactions
1. Each transaction is analyzed in terms of its effect on:
a. three components of basic accounting equation
b. specific types of items in each component
2. The two sides of the equation must always be equal.
3. Owner’s capital, owner’s drawings, revenues, and expenses indicate the causes of each change in
the owner’s claim on assets
the four financial statements
Income Statement
•
presents the revenues and expenses and resulting net income or net loss for a specific period of
time
[Name of the Company]
Income Statement
For the [period] ended [date]
Revenues
Service revenue
Expenses
Expense 1
Expense 2
Expense 3
Total expenses
Net income
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Statement of Changes in Owner’s Equity
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reports the changes in owner’s equity for a specific period of time
[Name of the Company]
Statement of Changes in Owner’s Equity
For the [period] ended [date]
Owner’s capital, Date
xxxx
Add: Investments
Add: Net income
xxxx
xxxx
xxxx
Less Drawings
Net loss
Owner’s capital, Date
xxxx
xxxx
xxxx
xxxx
Statement of Financial Position
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•
•
•
reports the assets, liabilities, and owner’s equity at a specific date
snapshot of the company’s financial condition at a specific moment in time
assets → liabilities → equity
total assets = total liabilities and owner’s equity
[Name of the Company]
Statement of Financial Position
as of [date]
Assets
Current Assets
Asset 1
Asset 2
Asset 3
Total assets
Owner’s Equity and Liabilities
Liabilities
Liability 1
Liability 2
Liability 3
Total liabilities
Owner’s Equity
Owner’s capital
Total owner’s equity and
liabilities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Statement of Cash Flows
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•
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•
•
provide financial information about the cash receipts and cash payments of a company for a
specific period of time
helps in the analysis of cash position
reports the cash effects of a company’s operating, investing, and financing activities
shows net increase/decrease in cash during the period, or the amount at the end of the period
answers the following:
o Where did cash come from?
o What was cash used for?
o What was the change in the cash balance?
[Name of the Company]
Statement of Cash Flows
For the [period] ended [date]
Cash flows from operating activities
xxxx
Cash receipts from revenues
Cash payments for expenses
Net cash provided by operating
activities
(xxxx)
xxxx
xxxx
Cash flows from investing activities
Purchase of equipment
Cash flows from financing activities
Investments by owner
Drawings by owner
Net increase in cash
Cash at the beginning of the period
Cash at the end of the period
xxxx
xxxx
(xxxx)
xxxx
xxxx
xxxx
xxxx
career opportunities in accounting
Public Accounting
• careers in auditing, taxation, and management consulting, serving the general public.
• offer expert service to the general public
A. Auditing
• examination of the company’s financial statements and provision of an opinion as to how
accurately the financial statements present the company’s results and financial position in
accordance with IFRS.
• done by an independent accountant:
o Chartered Accountant (CA)
o Certified Public Accountant (CPA)
B. Taxation
• tax advice and planning
• preparing tax returns
• representing clients before governmental agencies
C. Management Consulting
• ranges from:
o installing basic accounting software or highly complex enterprise resource planning
systems
o performing support for major marketing projects and merger and acquisitions activities
Private Accounting
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careers in industry working in cost accounting, budgeting, accounting information systems, and
taxation
Governmental Accounting
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careers with the tax authorities, law enforcement agencies, and corporate regulators
Forensic Accounting
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uses accounting, auditing, and investigative skills to conduct investigations into theft and fraud