Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
Objectives
1. Introduction to Accounting
• Define accounting.
• Describe the nature and purpose of
accounting.
• Give examples of branches of
accounting.
• State the function of accounting in a
business.
• Differentiate between external and
internal users of accounting information.
• Narrate the history/origin of accounting.
• State the forms of business organization.
• State the types of business according to
their activities.
THREE IMPORTANT ACTIVITIES
1. Identifying
2. Measuring
3. Communicating
IDENTIFYING
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INTRODUCTION TO ACCOUNTING
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DEFINITION
By the Accounting Standards Council,
Accounting is a service activity. The
accounting function is to provide
quantitative information, primarily financial
in nature, about economic entities, that is
intended to be useful in making economic
decision.
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By the American Institute of Certified
Public Accountants (AICPA)
Accounting is the art of recording,
classifying and summarizing in a
significant manner and in terms of money,
transactions and events which are in part
at least of a financial character and
interpreting the results thereof.
By the American Accounting Association
(AAA)
Accounting is the process of identifying,
measuring and communicating economic
information to permit informed judgment
and decision by users of the
information
Identifying
○
The process of analyzing events
and transactions to determine
whether or not they will be
recognized. Only accountable events
are
recognized.
In
general,
accountable events and transactions
should be:
■
Related to the business,
■
measurable in terms of
money,
■ and
documented or supported
by evidence.
Types of Events
○ External events - events that involve
an external party.
■ Exchange (reciprocal transfer) reciprocal giving and receiving
■
Non-reciprocal transfer - "one
wav" transaction
■ 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.
○ Internal events - events that do not
involve an external party.
■
Production - the process by
which resources are transformed
into finished goods.
■ Casualty - an unanticipated loss
from disasters or other similar
events.
Recognition
○ identifying something from previous
encounter or knowledge as well as
acknowledgment existence of validity
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1
Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
MEASURING
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Measuring
○ Involves assigning numbers,
normally in monetary terms, to
the economic transactions and
events.
The
several
measurement bases used in
accounting include, but not
limited to, the following:
■ historical cost,
■ fair value,
■ present value,
■ realizable value,
■ current cost,
■ and sometimes
inflation-adjusted cost
○ The most commonly used is
historical cost. This is
usually combined with the
other measurement bases.
Accordingly,
financial
statements are said to be
prepared using a mixture of
costs and values.
Valuation by fact or opinion
○ When
measurement
is
affected by estimates, the
items measured are said to be
valued by opinion.
○ When
measurement
is
unaffected by estimates, the
items measured are said to be
valued by fact.
COMMUNICATING
●
Communicating
○ The
process
of
transforming
economic data into useful accounting
information, such as financial
statements and other accounting
reports, for dissemination to users.
Types of accounting information
classified as to users' needs
1. General
purpose
accounting
information
a. designed
to
meet
the
common needs of most
statement users.
b. This information is governed
by the Philippine Financial
Reporting
Standards
(PFRSs).
2. Special
purpose
accounting
information
a. designed to meet the specific
needs of particular statement
users.
b. This information is provided
by other types of accounting,
e.g., managerial accounting,
tax basis accounting, etc.
Users of Accounting Information &
Products of Accounting
Users of Accounting Information are classified
as:
● Internal users
○ those who are directly involved in
managing the business
○ Examples:
■ Business owners who are directly
involved
in
managing
the
business,
■ Board of directors
■ Managerial personnel
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Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
●
External users
○ those who are not directly involved in
managing the business.
○ Examples:
■ existing and potential investors
(e.g., stockholders who are not
directly involved in managing the
business)
■ Lenders (e.g., banks) and
Creditors (e.g., suppliers)
■ Non-managerial employees
■ Public
Products of accounting are:
● Financial statements
○ 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
communicated to users.
● Accounting reports
○ 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
statements
Accounting Reports
1. Statement of
financial position
2. Statement of profit
or loss and other
comprehensive
income
3. Statement of
changes in equity
4. Statement of cash
flows
5. Notes
6. Additional statement
of financial
position
1. Statement of
financial position
2. Statement of profit
or loss and other
comprehensive
income
3. Statement of
changes in equity
4. Statement of cash
flows
5. Notes
6. Additional statement
of financial
position
7. Other information
Brief History of Accounting
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Accounting can be traced as far back as
the prehistoric times, perhaps more than
10,000 ears ago.
Archaeologists have found clay tokens as
old as 8500 B.C. in Mesopotamia which
were usually cones, disks, spheres and
pellets. These tokens correspond to
commodities like sheep, clothing or bread.
They were used in the Middle West in
keeping records. After some time, the
tokens were replaced by wet clay tablets.
During such time, experts concluded this
to be the start of the art of writing.
(Source:
http://EzineArticles.com/456988)
Double entry records first came out during
1340 A. D. in Genoa.
In 1494, the first systematic record
keeping dealing with the "double entry
recording system" was formulated by Fra
Luca Pacioli, a Franciscan monk and
mathematician.
The
"double entry
recording system" was included in
Pacioli's
book
titled
"Summa di
Arithmetica Geometria Proportioni and
Proportionista," published on November
10, 1494 in Venice.
The concept of "double entry recording" is
being used to this day. Thus, Fra Luca
Pacioli is considered as the father of
modern accounting.
PURPOSE OF ACCOUNTING
OVERALL OBJECTIVE OF ACCOUNTING
●
●
To
provide
quantitative
financial
information about a business that is useful
to statement users, in making economic
decisions.
The essence of accounting:
○ DECISION - USEFULNESS
3
Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
COMMON BRANCHES OF
ACCOUNTING
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Financial accounting
○ focuses on general purpose
financial statements.
Management accounting
○ focuses on special purpose
financial reports for use by an
entity's management.
Cost accounting
○
the systematic recording and
analysis of the costs of
materials, labor, and overhead
incident to production.
Auditing
○ the process of evaluating the
correspondence of certain
assertions with established
criteria and expressing an
opinion thereon.
Tax accounting
○
the preparation of tax returns
and rendering of tax advice,
such as the determination of
tax consequences of certain
proposed
business
endeavors.
Government accounting
○
refers to the accounting for
the government and its
instrumentalities,
placing
emphasis on the custody of
public funds, the purposes for
which
those
funds
are
committed,
and
the
responsibility
and
accountability
of
the
individuals entrusted with
those funds.
Forms of Business Organization
4
Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
Advantages and Disadvantages of the
Different Forms of Business
Organization
5
Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
Types of Business
According to Activities
●
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Service Business
○ A service business is one that offers
services as its main product rather
than physical goods. A service
business may offer professional
skills, expertise, advice, lending
service, and similar services.
○ Examples:
■ Schools
■ Professionals (accounting firm,
law firm, electrician, etc.)
■ Hospitals and clinics
■ Banks
and
other
financial
institutions
■ Hotels and restaurants
■ Transportation and travel (taxi
operator, travel agency, etc.)
■ Entertainment and event planners
(wedding
planners,
concert
promoters, etc.)
Merchandising Business
○ A merchandising business (or
trading business) is one that buys
and sells goods without changing
their physical form.
○ Examples
of
merchandising
businesses include:
■ General merchandise resellers
(grocery
stores,
department
stores,
hardware
stores,
pharmacies,
online
stores,
sari-sari stores, etc.)
■ Distributors and dealers (rice
wholesalers, vegetable dealers,
2nd-hand cars dealers, etc.)
Manufacturing business
○ A manufacturing business is one that
buys raw materials and processes
them into final products. Unlike a
merchandising
business,
a
manufacturing business changes the
physical form of the goods it has
purchased in a production process.
○ For example, a business that buys
and sells eggs is a merchandising
business. On the other hand, a
business that buys eggs and uses
●
●
the eggs as ingredient in making
cakes for sale is a manufacturing
business.
○ Examples
of
manufacturing
businesses include:
■ Car manufacturers (Toyota, Isuzu,
Volkswagen, etc.)
■ Technology companies (Apple,
Samsung, Sony, etc.)
■ Food processing companies (San
Miguel Pure Foods, Silver Swan,
etc.)
■ Factories
(clothing
factories,
animal feeds factories, plastic
wares factories, etc.)]
Some
businesses,
called
hybrid
businesses, engage in more than one
type of activity. For example, a restaurant
uses ingredients to cook a meal
(manufacturing), sells Coca-Cola drinks
(merchandising), and serves food to
customers (service).
Nevertheless, a hybrid business is
classified into one of the major types
based on the activity that is most in line
with the business purpose. Restaurants
are expected to fill-in customer orders and
provide dining services, thus, they are
more of a service-type business.
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Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
Chapter 1 Summary
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Accounting is a process of identifying,
measuring and communicating economic
information that is useful in making
economic decisions.
Only "accountable events" are recorded in
the books of accounts. Accountable events
are those that affect the assets, liabilities,
equity, income or expenses of a business.
The
information
processed
in an
accounting system is communicated to
interested users through accounting reports
(e.g., financial statements).
Accounting is considered the "language of
business" because it is essential in the
communication of financial information.
Accounting provides information that is
useful in making economic decisions.
The common branches of accounting
include the following: (1) Financial
accounting, (2) Management accounting,
(3) Government accounting, (4) Auditing,
(5) Tax accounting, (6) Cost accounting, (7)
Accounting education, and (8) Accounting
research.
Financial accounting focuses on the
information needs of external users, while
management accounting focuses on the
information needs of internal users.
External users are those who are not
directly involved in managing the business.
Internal users are those who are directly
involved in managing the business.
Accounting information may be either (a)
general purpose or (b) special purpose.
General purpose accounting information is
provided by financial accounting and is
prepared primarily for external users.
Special purpose accounting information is
provided by management accounting or
other branches of accounting and is
prepared primarily for internal users.
The
different
forms
of
business
organization are: (1) Sole proprietorship,
(2) Partnership, (3) Corporation, and (4)
Cooperative.
The types of business according to
activities are: (1) Service business, (2)
Merchandising
business,
and
(3)
Manufacturing business.
7
Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
Objectives
ASSUMPTIONS
2. Accounting Concepts and Principles
● Give examples of accounting
concepts and principles.
● Apply the concepts in the solving
of accounting problems.
ASSUMPTIONS MNEMONICS
●
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ACCOUNTING CONCEPTS
AND PRINCIPLES
DEFINITION
●
Accounting Concepts and Principles
these refere to the principles of which the
process of accounting is based. This is
sometimes
referred
ito
accounting
assumptions, accounting postulates, or
accounting theory.
Generally
Accepted
Accounting
Principles (GAAP) these represent the
rules,
procedures,
practices,
and
standards followed in the preparation and
presentation of financial statements.
These are like laws that must be followed
in financial reporting.
●
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Seperate Entity
Monetary Unit
Time Period
Going Concern
SMTG
Seperate Entity Concept
○ This is also known as accounting
entity concept, business concept, or
entity concept.
○ Entity concept this means that the
entity or the business itself is viewed
separately from its owner just like
iron man when he has his alter ego
tony stark so they are considered
separate
entities
business
transactions are recorded in the
business records but personal
transactions of the owner's are not
recorded in the business records so
that is what separate entity concept
is
Monetary Unit Assumption
○ This is also known as stable
monetary unit assumption or unit of
measure concept.
○ This means that of financial
information are stated in terms of a
common unit of measure which is in
the philippines it is the Philippine
peso that would mean that assets,
liabilities, equity, income, and
expenses should be stated in a
common denominator. If there are
foreign
currency
denominated
transactions
this
should
be
translated into pesos so if the report
is also in the US then all financial
informations are to be reported in the
US dollar currency.
Time Period Assumption
○ This is also known as periodicity or
accounting period assumption.
○ This means that the life of the entity
is divided into series of reporting .
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Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
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this is usually 12 months or one
calendar year or one fiscal year. This
can also be divided further into
quarterly or monthly show the life of
a business entity should be
subdivided into a series of reporting
periods.
Going Concern Assumption
○ There a need to divide the life of the
entity into a series of reporting
periods that is also because there is
what you call a going concern
assumption
○ This assumption means that the
entity is assumed to carry on its
operations for an indefinite period of
time and since because the
assumption is the life of the entity is
infinite so it should be subdivided
into reporting period so that financial
information can be prepared any
smaller chunks of time rather than
waiting for the end of the entity's life.
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PRINCIPLES
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PRINCIPLES MNEMONICS
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Dual Aspect
Accrual Basis
Matching
Historical Cost
Full Disclosure
HDFAM
Dual Aspect Concept
○ States
that
every
business
transaction requires to be recorded
into different accounts this concept is
the basis of double entry accounting
which is when there is a debit there
should also be a credit the double
entry. Accounting is required by all
accounting frameworks in order to
produce reliable financial statement
Accrual Basis of Accounting
○ it means that the effects of
transactions and other events are
recognized when they occur and
they are recorded in the accounting
records and reported in the financial
statements of the period to which
they relate. This means that income
is recognized when earned instead
of when payment is received and
that expenses are recognized when
incurred rather than when the
business has made payment.
Matching Concept
○ This is also known as the association
of cause and effect
○ This
means
that
costs are
recognized as expenses when the
related revenue is recognized
meaning the expenses are matched
against the revenues.
Historical Cost Concept
○ They
generate historical cost
concept or cost principle states that
the value of an asset is determined
on the basis of acquisition cost this
concept is not always maintained or
applied because this is just generally
applied which is why it's called a
generally
accepted
accounting
principle
Full Disclosure Principle
○ This is also known as adequate
disclosure concept.
○ This concept requires that the
financial statements including the
related notes contain all relevant
data a stakeholder needs to
understand the financial condition
and performance of the company
non-essential data are excluded to
avoid qatar now the sufficient details
to be disclosed is also being traded
off for sufficient condensation of
information to keep the information
understandable without having to
spend a lot of cost in preparing it.
9
Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
CONVENTIONS
CONVENTIONS MNEMONICS
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Materiality
Cost Benefit
Conisistency
Conservatism
M3Cs
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Materiality concept
○ States that information is material if
it's omission or misstatement would
influence
economic
decisions
because remember the objective of
accounting is to enable the users to
make decisions or make the
information
useful
in
making
decisions and materiality is a matter
of professional judgment it is based
on the size and nature of the item
being judged. A 10 million loss for a
large company may not be material
versus that of a smaller company
materiality thresholds are not set by
any standards rather it is based on
the professional judgment of the
accountant or accountants involved.
Cost Benefit
○ This is also known as cost constraint
and reasonable assurance.
○ This states that the cost of
processing
and
communicating
information should not exceed the
benefits to be derived from it
meaning when preparing financial
statements and accounting reports
and in gathering the level of details
to be disclosed in the report must not
exceed the cost in preparing these
details versus that of the benefit that
the user will get in making decisions
from said information.
Consistency Concept
○ States that the financial statements
are prepared on the basis of
accounting principles that are
applied consistently or the same
from one to the next if there are
changes in the accounting policies.
This can only be made when it is
required or permitted by the
Philippine
Financial
Reporting
Standards (PFRS) or when the
change results to more relevant and
reliable information changes in
accounting policies should be
disclosed in the notes to financial
statements.
Conservatism
○ This is also known as prudence.
○ This is when the use of caution in
making estimates under conditions
of uncertainty such that assets or
income are not overstated and
liabilities or expense are not
understated
meaning
when
exercising conservatism making
estimates should be made based on
the least effect on equity meaning.
○ If you have to choose between an
estimated income of 100 versus 99
prudence would dictate that you
would choose the estimated income
of 99 or if there is an estimated
expense of 50 versus 49 the 50 is
chosen as the estimated expense
show prudence means you will try
not to get an estimate that will have
a bigger effect, so you aim for the
estimate that will have the least
effect in increasing your equity.
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Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
GENERAL STANDARDS
Accounting Standard Setting Bodies
and Other Relevant Organizations
11
Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
Difference between
US GAAP and International GAAP
THE ACCOUNTING EQUATION
The basic accounting equation:
The expanded accounting equation:
Definitions
● ASSETS
○
the economic resources you control
that have resulted from past events
and can provide you with economic
benefits.
● LIABILITIES
○
your present obligations that have
resulted from past events and can
require you to give up economic
resources when settling them.
● EQUITY
○ assets minus liabilities.
● INCOME
○ increases in economic benefits
during the period in the form of
increases in assets, or decreases in
liabilities, that result in increases in
equity, excluding those relating to
investments by the business owner.
12
Financial Accounting and Reporting
PRELIM Notes
AEC 12 | Ms. Zola Mae D. Caumban | 1ST YR - SEM 1
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EXPENSES
○ are decreases in economic benefits
during the period in the form of
decreases in assets, or increases in
liabilities, that result in decreases in
equity, excluding those relating to
distributions to the business owner.
The difference between income and
expenses represents profit or loss.
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THE MAJOR ACCOUNTS
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Account
○ The basic storage of nformation in
accounting. It is a record of the
increases and decreases in a
specific item of asset, liability, equity,
income or expense.
T-Acoounts
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The Five Major Accounts
○ ASSETS, LIABILITIES, EQUITY
INCOME, & EXPENSES
Classification of Five Major Accounts
BALANCE SHEET
ACCOUNTS
INCOME
STATEMENT
ACCOUNTS
ASSETS
LIABILITIES
EQUITY
INCOME,
EXPENSES
CHART ACCOUNTS
●
Chart of Accounts
○ a list of all the accounts used by a
business.
Balance Sheet Accounts
○ Assets
■ Cash
■ Accounts receivable
■ Allowance for bad debts
■ Notes receivable
■ Prepaid supplies
■ Prepaid rent
■ Prepaid insurance
■ Land
■ Building
■ Accumulated
depreciation
Building
■ Equipment
■ Accumulated
depreciation
equipment
○ Liabilities
■ Accounts payable
■ Notes payable
■ Interest payable
■ Salaries payable
■ Utilities payable
■ Unearned
○ Equity
■ Owner's capital (or Owner's
equity)
■ Owner's drawings
Income Statement Accounts
○ Income
■ Service fees
■ Sales
■ Interest income
■ Gains
○ Expenses
■ Cost of sales (or Cost of goods
sold)
■ Freight-out
■ Salaries expense
■ Rent expense
■ Utilities expense
■ Supplies expense
■ Bad debt expense
■ Depreciation expense
■ Advertising expense
■ Insurance expense
■ Taxes and licenses
■ Transportation and travel
expense
■ Interest expense
■ Miscellaneous expense
■ Losses
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