2. Introduction
Accounting helps businesses track events that affect them. This process involves:
• Identifying – events that affect the business
• Recording – events
• Communicating – summarized results of all events within a particular period to
interested parties
Example :
sale of cars is an economic event that affect car manufacturers and retailers. This
transaction will be recorded and consolidated by the end of the month . The
consolidated records can be used by the top management to identify potential
problems encountered by the company and analyse profits. This can also be used to
attract potential investors
CHAPTER 1: INTRODUCTION TO
ACCOUNTING
3. LC 1
The American Accounting Association (AAA) defines accounting as …
“ the process of identifying, measuring and communicating economic
information to permit informed judgements and decisions by the users of
information
American Institute of Certified Public Accountant (AICPA) defines accounting
as….
“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
in character and interpreting the results thereof.”
ACCOUNTING DEFINED
4. THE ACCOUNTNG PROCESS
1st Step IDENTIFYING
2nd Step RECORDING
3rd Step SUMMARIZING
CHAPTER 1: INTRODUCTION TO
ACCOUNTING
5. • Accounting is a process.
• Accounting is an art.
• Accounting deals with financial information and transactions.
• Accounting is a means and not an end.
• Accounting is an information system.
NATURE OF ACCOUNTING LC 2
6. From the definition of accounting , the following functions are derived:
1. Keeping systematic record of business transactions
2. Protecting properties of the business
3. Communicating results to various parties in or connected with the business
4. Meeting legal requirements
FUNCTIONS OF ACCOUNTING LC 3
7. 1. Ancient Mesopotamia – people followed a system of writing
and counting money. Development of accounting may be
related to the taxation and trading activities of temples.
2. Emperor Augustus (63BC-14AD) – Stewardship of Roman
resources. The Roman Government kept detailed financial
information of the deed of Emperor Augustus as evidenced by
the Res Gestae Divi Augusti (The Deeds of the Divine Augustus).
Augustus prepared a rationarium (account) which listed public
revenues, amounts of cash in the aeranium (treasury), in the
provincial fisci (tax officials) and in the hands of publicani (public
contractors)
3. .
HISTORY OF ACCOUNTING LC 4
8. 3. Double Entry Bookkeeping (14th Century –Italy) – The
most important event in accounting history. Luca Pacioli,
the Father of Modern Accounting authored “ Summa de
Arithmetica, Geometria, Proportioni et Proportionalita” (
Review of Arithmetic, Geometry, Ratio and Proportion),
the first book printed with treatise on bookkeeping.
4. Modern profession of the chartered accountant originated
in Scotland when Queen Victoria granted a royal charter to
the Institute of Accountants in Glasgow.
5. At present, accounting standards like Philippine Financial
Reporting Standards (PFRS) and Philippine Accounting
Standards (PAS) are available to guide accountants in the
practice of their profession.
HISTORY OF ACCOUNTING LC 4
11. FINANCIAL ACCOUNTING
LC 5 &
LC6
Definition :
Is a branch of accounting primarily handling the recording
of financial transactions of a business. The financial
transactions are later summarized into financial
statements, for the benefit of internal and external users.
12. FINANCIAL ACCOUNTING
LC 5 &
LC6
• Type of Report Generated:
• Financial statements- provide information useful to a wide range of
users in their economic decisions. It deals with the financial
transactions of a business.
• Philippine Financial Reporting Standards (PFRS) and Philippine
Accounting Standards (PAS) supply guidelines on how companies
should prepare their financial statements. Standardized financial
statements allow the users to compare the results of operations of
different companies regardless of size and nature
• Standardized financial reports improve the understandability of the
company’s financial statements. Suppliers and creditors will be able to
assess the riskiness of a company through the well-presented financial
statements.
13. FINANCIAL ACCOUNTING
LC 5 &
LC6
• Example, Lenie plans to invest her savings in Jollibee ,
Chowking or Greenwich. Before she makes her decision,
it is only rational for her to compare the three food
companies and see which one will most likely be the most
profitable investment. Even if these companies belong to
the same industry, different presentations of the
companies’ financial statements will make it hard for her to
choose which company she would invest in. A
standardized way of presenting financial statements
enhances the comparability of different companies.
14. FINANCIAL ACCOUNTING
LC 5 &
LC6
Purpose of Information:
• Financial accounting caters to the need of both
internal and external users.
• Financial accounting’s main goal is to provide the
quantitative information needs of external users.
Frequency of Report:
Periodic (Annually, Quarterly etc.)
Standards/Basis of Presentation:
PFRS and PAS
15. GENERAL PURPOSE FINANCIAL
STATEMENTS
LC 5 &
LC6
⮚General purpose financial statements- used external parties to evaluate
the performance of the company.
⮚Specific purpose financial statements - utilized by internal parties to guide
them in the decision-making process for the company.
16. MANAGEMENT ACCOUNTING
LC 5 &
LC6
Definition:
Is a branch of accounting which focuses on the preparation of financial
reports used by managers in their day-to-day decision making.
Types of Report Generated:
Managerial Report. As such, management reports need not follow
accounting standards such as the PFRS and PAS as it is for internal
users only.
Purpose of Information :
Helps management in decision making
.
17. MANAGEMENT ACCOUNTING
LC 5 &
LC6
Frequency of Reports:
Management reports can be done daily, weekly, or whenever managers
require a specific report.
Management reports typically contain information regarding the amount
of cash on hand, the level of sales revenue for a particular period, costs
incurred, or even the comparison of actual results with budgeted amounts.
Standards/ Basis of Presentation:
None
18. MANAGEMENT ACCOUNTING
LC 5 &
LC6
Financial Accounting versus Management Accounting
• Management accounting differs from financial accounting in the nature of
information produced. (Internal users)
• Financial accounting summarizes financial information gathered within a
specified period. Thus, financial accounting provides information that is
historical. Meanwhile, management accounting information is forward-
looking. It contains forecasted information used by managers in planning.
19. GOVERNMENT ACCOUNTING
LC 5 &
LC6
Definition:
According to Section 109 of Presidential Decree 1445,
government accounting is defined as an accounting system
which “encompasses the process of analyzing, recording,
classifying, summarizing, and communicating all transactions
involving the receipt and disposition of government fund and
property and interpreting the result thereof.”
20. GOVERNMENT ACCOUNTING
LC 5 &
LC6
Purpose of the Information:
Shows stewardship of the government of public resources. We do not want the
country’s funds to be used for personal reasons by erring public officials.
Instead, we want these funds to be used for public projects that will benefit
many constituents
.
Type of reports generated:
Periodic financial reports ; financial statements of the government.
Frequency of Report:
Periodic (Annually, Quarterly etc.)
21. GOVERNMENT ACCOUNTING
LC 5 &
LC6
Intended Users:
External and Internal Users
Standards/Basis of Presentation:
New Government Accounting Standards
enhances responsibility accounting in all agencies. Simply stated,
responsibility accounting relates financial results to a particular
responsibility center (i.e., agency). If there is a problem with the handling
of funds by the DPWH, for example, people in that agency will be the ones
accountable. This system of placing accountability in each agency
discourages misappropriation and misuse of public funds.
22. GOVERNMENT ACCOUNTING
LC 5 &
LC6
The government accounting process involves the
Commission on Audit (COA), the Department of
Budget and Management (DBM), the Bureau of
Treasury (BTr), and all other government agencies.
23. GOVERNMENT ACCOUNTING
LC 5 &
LC6
COA is responsible for the keeping of the government’s general accounts. The
COA is tasked to keep and update the accounting books of the whole organization.
Moreover, the COA disseminates accounting rules and regulations to be used by
all agencies
DBM shall be responsible for the formulation and implementation of the
National Budget. It shall be responsible for the efficient and sound utilization of
government funds and revenues to effectively achieve the country’s development
objectives.”
BTr is responsible for the safekeeping of the national funds. It serves like a bank
where the funds are kept. Although its main role is the safekeeping of funds, the
BTr is also responsible for the management and control of the disbursements of
such funds. Furthermore, the agency is also responsible in maintaining accounts
of financial transactions of all natural government agencies
24. AUDITING
LC 5 &
LC6
Definition :
Is an unbiased examination and evaluation of the financial statements of an
organization (Investopedia.com). Auditing is a process that includes numerous
steps to determine whether or not a company’s financial statements are presented
truthfully.
Auditors, aside from having the competence to perform their roles, should also be
independent from the company being audited. Independent auditors have no
connection with the company. Example : If an employee of the company is the
one who examines and evaluates the financial statements, the fear of the users that
the results are manipulated will not be alleviated.
25. AUDITING
LC 5 &
LC6
Definition :
Is an unbiased examination and evaluation of the financial statements of an
organization (Investopedia.com). Auditing is a process that includes numerous
steps to determine whether or not a company’s financial statements are presented
truthfully.
Auditors, aside from having the competence to perform their roles, should also be
independent from the company being audited. Independent auditors have no
connection with the company. Example : If an employee of the company is the
one who examines and evaluates the financial statements, the fear of the users that
the results are manipulated will not be alleviated.
26. AUDITING
LC 5 &
LC6
Type of report generated:
Financial statements that underwent the process of auditing
are called audited financial statements. A set of the financial
statements will only be useful to users after it has gone
through the process of auditing. Auditor’s report contains the
auditor’s opinion about the financial statements. The auditor’s
opinion will be the basis whether or not the financial
statements are prepared truthfully and without any material
errors.
.
27. AUDITING
LC 5 &
LC6
Purpose of Information:
Gives credibility to the financial statements of the company.
Frequency of reports:
After every audit set of financial statements.
Intended Users:
External Users
Standards or Basis of Presentation:
Philippine Standard on Auditing
28. TAX ACCOUNTING LC 5 &
LC6
Definition:
Tax accounting enables the taxing authorities to collect taxes
that differ from the amount due computed using the financial
accounting standards
TAXES are the lifeblood of the government. Without the taxes the citizens pay, the
government cannot perform its functions. Thus, it is imperative that the collection
of taxes be unhindered.
29. TAX ACCOUNTING LC 5 &
LC6
Purpose of Information:
Helps determine the amount of Taxes Payable.
Frequency of reports:
Periodic
Intended Users:
Taxing Authorities
Standards or Basis of Presentation:
NIRC
30. COST ACCOUNTING
LC 5 &
LC6
DEFINITION:
Is a branch of accounting that provides information for management
accounting and financial accounting
For example, cost accounting helps measure the cost of a bicycle for a
bicycle-selling company. This information supports management in
deciding how many bicycles to produce, the selling price of the bicycle, or
valuing the inventory of bicycles in the company’s financial statements.
31. COST ACCOUNTING
LC 5 &
LC6
Types of report Generated:
Cost of Production Report and other cost reports
Purpose of information:
Finds the cost of a particular product
Frequency of reports:
Periodic
Intended Users:
Internal and External Users
Basis of Reporting: None
32. ACCOUNTING EDUCATION
LC 5 &
LC6
Definition: Deals with the promulgation of accounting knowledge to various
interested parties that will aid them in achieving their individual goals.
Purpose of Information: Educates students in the field of accountancy
Intended users: Students and members of the academe
33. ACCOUNTING RESEARCH
LC 5 &
LC6
Definition: is a branch of accounting that deals with the creation of new
knowledge.
Purpose of Information: Research results:
1. Deciding and implementing new accounting and auditing standards
2. Presenting unusual economic transactions in the financial statements
3. Learning how new tax laws impact clients and employers
4. Discerning how the accounting profession affects the capital markets through
academic accounting research
Intended users: Primarily members of the academe
35. CONTENT Users of Accounting Information
CONTENT
STANDARDS
The learners demonstrate an understanding of…
the external and internal users of financial information
PERFORMANCE
STANDARDS
The learners shall be able to…
1. solve exercises and problems on the identification of users of
information, type of decisions to be made, and type of
information needed by the users
2. cite users of financial information and identify whether they
are external or internal users
LEARNING
COMPETENCIES
1. Differentiate the branches of accounting
ABM_FABM11- IIIa-5
2. Explain the kind/type of services rendered in each
of these branches
ABM_FABM11-IIIa-6
36. CUSTOMERS
⮚ Customers are the main source of income of businesses. It can even be
claimed that most businesses are established solely for the service of their
customers.
⮚ Businesses usually aim to widen their reach by targeting multiple customers
segments.
⮚ All of us have been a customer at some point in our lives. When you bought
shampoo in the nearby sari-sari store, you are considered a customer.
⮚ Simply put, customers are people or entities that acquire goods and services
for a fee.
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7
37. CUSTOMERS
⮚ By analyzing the accounting information of a business, customers can
determine if it will be profitable for them to transact with the business
⮚ Normally, customers note a company’s income, which is a good indicator of
the profitability of a company. A profitable result of operations is a signal
that the customers will take minimal risk if they decide to deal with the
company. Occasionally, customers also try to know the future commitments
of the company (e.g., plans for expansion of the business or to discontinue a
business segment) since it will affect their long-term plans as well.
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7
38. CUSTOMERS
⮚ Example: Patricia plans to organize a furniture shop. She wants her business
to take off by building the furniture from scratch. However, the materials
needed to build the furniture will be purchased from an outside supplier.
Patricia has two possible suppliers: Dayana Company and Dray Company.
For the last 5 years, Dayana Co. and Dray Co. displayed positive income in
their financial statements with Dray Co. having a slightly higher income on
the average than Dayan Co.’s. Both companies are regarded as reliable
suppliers. But during the last year, Dray Co. experienced problems in its
operations due to a labor strike preventing it from fulfilling all orders. What
company should Patricia choose as her supplier?
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7
39. CREDITORS
⮚Creditors lend their resources (usually money) to the business in exchange for a fee.
The fee charged by creditors is the payment for the use of their resources.
⮚Before creditors grant loans to a business, they first examine its financial
statements. The biggest fear of creditors is that they will not get paid the amount due
to them.
⮚Creditors would not lend to a risky company. However, there are creditors who still
offer their money to these companies in exchange for higher interest rates or lending
fees. As a rule of thumb in the field of finance, “high risk, high return.”
⮚ .
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7
40. CREDITORS
Three main factors considered by creditors before lending to a company:
1. Riskiness of lending
2. Profitability of the company
3. Company’s amount of borrowings
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7
41. CREDITORS
Three main factors considered by creditors before lending to a company:
1. Riskiness of lending
2. Profitability of the company
3. Company’s amount of borrowings
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
42. POTENTIAL INVESTORS
⮚ Financial statements provide potential investors the necessary information to
decide if they will invest in the business.
⮚ The level of profits presented in the financial statements is a primary
concern for investors. This information is a key indicator if an investment
will be profitable.
⮚ Unlike creditors who are assured to earn the interest and fees, investors may
win or lose in their investment. Investing in a business is a gamble.
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
43. POTENTIAL INVESTORS
⮚ Investors are even more afraid than creditors of the possibility that they will
lose their money. In the event that a company becomes insolvent (i.e., assets
are less than the liabilities), creditors are paid first before the investors. There
are individuals who invest in companies that are risky. An example of such
company is a startup company. If their gamble is successful, individuals who
invest in such companies will earn higher rates of return.
⮚ Investors also evaluate the company’s financial ratios to get a feel of how the
company operates. Investors look out for the earnings retention policy of a
company as well.
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
44. POTENTIAL INVESTORS
⮚ Example: Aryana is a successful career woman. During her 15-year tenure as
an engineer, she amassed a total of ₱10M in savings. Instead of placing her
money in the bank, which earns only 2% in interest every year, she plans to
invest in either Shell or Petron. Shell and Petron are two of the largest oil
companies in the country. After analyzing the financial statements of both
companies, Aryana noted that Petron and Shell earned high levels of profit
for the past 2 years with Petron garnering Php40M more in profits. In
addition, Petron is planning to expand the business which is expected to
bring in more profits for the company.
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
45. POTENTIAL INVESTORS
Based on the facts given, it is more probable that an investment in
Petron will be the more profitable investment in the long run. As
illustrated in this example, both the company and the investor will
benefit from the communication of accounting information.
Investors can make better informed decisions while companies can
attract potential investors to provide additional funds.
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
46. GOVERNMENT
⮚ primarily to regulate the businesses in the economy, but can also invest in or
lend money to businesses.
⮚ The government, particularly the taxing authorities, also uses the financial
statements to compute for the amount of taxes payable by a company.
Companies’ desire to pay lower taxes might encourage them to understate
revenues and overstate expenses to the detriment of the public. Taxing
authorities guarantee that this wrongdoing does not occur.
The government particularly looks at the income, revenues, and expenses of a
company. Officials want to ensure that companies do not overstate their income
to attract more investors and creditors. Investing huge amounts of money in a
company with lower than perceived value can be very harmful for the economy.
Revenues and expenses are closely scanned for taxing purposes.
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
47. GOVERNMENT
Example:
⮚ The Bureau of Internal Revenue (BIR) is responsible for the
assessment and collection of taxes from its constituents. As you
probably heard in the news, BIR is strengthening its collection
policies to provide more funds for the government to use.
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
48. ACADEME
⮚ Although they do not usually transact with businesses, members
of the academe (e.g., professors, researchers, students) utilize
financial statements for academic purposes.
⮚ Financial statements also serve as a blueprint to help students in
understanding the field of accountancy
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
49. PUBLIC
⮚ Financial statements give us hints about the condition of the
economy. If the economy is not doing well, the general public
cut on their spending and increase their savings. The contrary is
true if the economy is prosperous. By analyzing the financial
statements of companies, the public can properly respond to the
various economic cycles.
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
50. PUBLIC
Other decisions of the public that can be affected involves:
⮚ Whether or not it is wise to start a business given the current
economic conditions;
⮚ To stay on a current job or look for a higher-paying job;
⮚ Determining the best use of a person’s resources (i.e., where to
put your money); and
⮚ Determining the optimal level of savings and consumption.
CHAPTER 3: EXTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
51. MANAGEMENT
⮚ Management is composed of employees within the company that
can implement decisions affecting the company’s operations,
such as members of the board of directors, top management,
middle-level managers, and supervisors are the common classes
of employees belonging to the management group. They will be
referred to here as “managers.”
⮚ All managers must know the company inside and out. By
examining financial statements, managers are able to identify
problems and respond to them accordingly.
CHAPTER 3: INTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
52. MANAGEMENT
⮚ Some problems faced by managers include, but is not limited to, the
following:
1. What areas of the business are becoming problematic?
2. What segments of the business underperformed during the last
period? What is the cause of such underperformance?
3. Is the level of company expenses becoming alarming?
4. How does the company handle its debt? Is the company incurring too
much borrowing that will be difficult to pay in the long run?
5. Does the company use its resources in the best possible way?
CHAPTER 3: INTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
53. MANAGEMENT
⮚ Example: Fix It Beauty Salon is one of the largest and most
successful salons in the country. For the past 5 years, Fix It
earned significant amounts of profits. Financial statements from
the previous year indicated a net income of ₱10M. During the
first quarter of the ensuing year, revenues of the company are
well below budgeted amounts. The first quarter’s poor
performance alarmed the owners, so they ask Mr. Louie Tan,
head of company operations, to identify and solve the problem.
CHAPTER 3: INTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
54. MANAGEMENT
⮚ By examining the financial statements, Mr. Tan noticed that 10
out of 25 branches of Fix It had revenues below the budget. He
also noticed that the marketing and advertising expenses of these
branches were also materially below the budget. He found out
that managers of these branches cut on the advertising expense
in hopes of improving the net income figure. This plan obviously
backfired since revenues lost are greater than the savings from
marketing and advertising. Mr. Tan immediately ordered the
managers of these branches to follow the proposed advertising
expense in the next quarter.
CHAPTER 3: INTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
55. EMPLOYEES
Employees are concerned with the company’s profitability. If the
company they are working for is profitable, employees feel that they
will timely and adequately receive their compensation and additional
benefits.
The current condition of a company also impacts employee morale
and performance. Companies that are performing well almost
always have employees that are motivated. On the other hand,
employee demotivation might be the effect of not meeting
company goals.
CHAPTER 3: INTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
56. OWNERS OR STOCKHOLDERS
⮚ Owners or stockholders are the existing investors of the
company. Some owners or stockholders take an active role in the
management of the business while others just wait for the
generation of profits. Whatever their role in the business might
be, all owners or stockholders are interested in the results of
company operations.
⮚ Owners or stockholders want to know if their investments will
yield acceptable returns. A profitable business keeps its investors
happy.
CHAPTER 3: INTERNAL USERS OF
ACCOUNTING INFORMATION
LC 7 to
LC 10
57. There are four forms of business organizations available
to aspiring businessmen — sole proprietorship,
partnership, corporation, and cooperative.
FORMS OF BUSINESS
ORGANIZATIONS
LC 11 to
LC 12
59. ⮚ Simplest form of under which a business can operate, sole proprietorships
are businesses formed by a single individual, but unlike partnerships and
corporations, businesses operating under such setup do not have separate
legal existence from the owner. The law does not recognize a sole
proprietorship as a separate juridical entity distinct from the owner. As such,
the owner usually transacts with other parties under his or her own name.
⮚ Sole proprietorships do not have separate legal existence, owners can opt to
operate the business under their own names or use fictitious names such as
Aling Nene Sari-Sari Store. Fictitious names are merely trade names that aim
to instill recall to customers.
FORMS OF BUSINESS
ORGANIZATIONS
LC 11 to
LC 12
60. 1. Ease of formation
⮚ Sole proprietorships are much easier to establish than other forms of
business organizations because it does not have to go through a rigid
registration process before it can operate.
⮚ Here in the Philippines, sole proprietorships can register in the local
municipal hall. Business permits and other licenses can also be acquired from
such places. The whole process is easy and inexpensive, and it normally
spans for only a short amount of time.
⮚ Sole proprietorships can be formulated even with small amounts of capital.
Carinderias and sari-sari stores are prevalent businesses operating as sole
proprietorships which do not require huge amounts of investments.
ADVANTAGES OF A SOLE
PROPRIETORSHIP
LC 11 to
LC 12
61. 2. The owner has full control of the business
⮚ The owner can single-handedly decide on matters pertaining to
the business. Unlike partnerships and corporations that
regularly hold meetings to make company decisions, sole
proprietors can easily make decisions to solve problems faced
by the business. The importance of fast decision-making is
emphasized when problems warrant immediate action.
⮚ A sole proprietorship does not experience internal conflict
regarding business decisions. Internal conflict can be harmful
business. In the worst case scenario, it can even be the cause of
the downfall of the business.
ADVANTAGES OF A SOLE
PROPRIETORSHIP
LC 11 to
LC 12
62. 3. Owners can mix personal and business assets
⮚ Owners may freely mix their personal assets with business
assets since sole proprietorships are not separate juridical
entities distinct from the owners unlike partnerships and
corporations do not have this advantage.
⮚ If a business is experiencing financial difficulties, a sole
proprietor may use personal assets to help the business
recover.
ADVANTAGES OF A SOLE
PROPRIETORSHIP
LC 11 to
LC 12
63. 4 . Owners have all the profits for themselves
All the profits generated by a business operating as a sole
proprietorship belong to the owner. The determination of profit-
sharing schemes is often a problem encountered by other forms of
business organization.
5. Simple taxation
The profits of a sole proprietorship are considered the income of
the owner. Thus, the owner needs only to declare the income of the
business in his or her tax return and it will be taxed accordingly.
ADVANTAGES OF A SOLE
PROPRIETORSHIP
LC 11 to
LC 12
64. 1. Unlimited liability
An owner of a sole proprietorship is personally liable for all the
debts incurred by the business since a sole proprietorship has no
separate legal existence distinct from the owner. The owner and the
sole proprietorship are treated as one.
Unlimited liability means that creditors, customers, the government,
and other outside parties can go after the personal assets of the
owner even after extinguishing all the assets of the business in the
satisfaction of their claims. This is a huge risk that sole proprietors
face. The law does not provide protection to the personal assets of
the owner unlike in corporations.
DIS ADVANTAGES OF A SOLE
PROPRIETORSHIP
LC 11 to
LC 12
65. 2. Difficulty of raising additional capital
⮚ When all of the initial investment is used up, the owner is
the only person that can provide additional capital. A sole
proprietorship cannot sell interest (i.e., ownership rights) in
the business. Doing so would defeat the purpose of being
a sole proprietorship.
⮚ In case a sole proprietor does not have enough resources
to use as capital, the only remedy available to the business
is to look for creditors willing to lend additional funds..
DIS ADVANTAGES OF A SOLE
PROPRIETORSHIP
LC 11 to
LC 12
66. 3. Owner’s bias
⮚ Only the sole proprietor has the authority to make decisions for
the business. When deciding how the company will move
forward, the owner always has the final word. This can possibly
be detrimental to the business especially when the owner’s bias
prevails and he or she does not make rational decisions.
⮚ Having more decision makers is equivalent to having more
minds to think of ideas on how to improve the business or how
to solve problems encountered by the business. The workload
of a sole proprietor is also much heavier than the owners of
other forms of business organizations.
DIS ADVANTAGES OF A SOLE
PROPRIETORSHIP
LC 11 to
LC 12
67. A partnership is a contract whereby two or more persons bind
themselves to contribute money, property, or industry to a
common fund, with the intention of dividing the profits
among themselves. Two or more persons may also form a
partnership for the exercise of a profession.
PARTNERSHIP
LC 11 to
LC 12
68. From this definition of partnership given by the law, we can take note of the
following:
1. Two or more persons are needed to form a partnership.
2. Money is not the only resource that a person can contribute in a partnership.
Property refers to other assets owned by a person. Examples are land, building,
vehicles, etc. Industry refers to the skills and expertise of a person.
3. A partnership must be established for the purpose of obtaining profit. If an
organization is created for purposes other than the generation of profit (e.g.,
charitable institutions, public hospitals), it cannot take the form of a partnership.
4. Partnerships are the common form of business organizations used by
companies who generate profits by the practice of a profession (e.g., law firms,
auditing firms).
PARTNERSHIP
LC 11 to
LC 12
69. Separate legal existence
A partnership can enter into contracts under its own name. A partnership
can also acquire property under its own name. Property acquired by the
partnership belongs to the partnership not to the individual partners.
However, even if a partnership has separate legal existence, its income is
not taxed as a separate entity. After the income has been distributed to the
partners, it will be included in their respective tax returns and it will be
taxed accordingly.
. Some examples of these acts are voting in elections and holding
positions in public office.
2
GENERAL FEATURES OF A
PARTNERSHIP
LC 11 to
LC 12
70. 2. Mutual agency
Partners, being co-owners of the business, can perform acts
for the partnership even without asking permission from other
partners. Mutual agency means that the acts of a partner are
binding on a partnership even though he or she has no
authority to do so as long as the act concerns the normal
business operations of the partnership.
GENERAL FEATURES OF A
PARTNERSHIP
LC 11 to
LC 12
71. 2. Mutual agency
Example:
Andre, Bart, and Charles formed a partnership called ABC
Partnership. ABC Partnership is engaged in the business of
manufacturing clothes. The three partners divided the tasks in
operating the partnership among them. Andre, being a graduate
with a degree in human resource management, was designated to
handle anything employee-related. Last week, Andre bought 10
sewing machines from DEF Company. Andre clearly exceeded the
authority given to him since he was not assigned to purchase
equipment for the company. Is the act of Andre binding on the
partnership?
GENERAL FEATURES OF A
PARTNERSHIP
LC 11 to
LC 12
72. 2. Mutual agency
Example:
The answer is yes. Sewing machines are normally used by
businesses engaged in the manufacturing of clothes. Even though
Andre has no authority to perform the act, the act itself is related to
the normal business operations. Suppose Andre purchased instead a
brand new speedboat using the partnership’s asset. In this case, the
partnership is not liable since the act clearly has no relation to the
partnership operations. Andre is the only one liable and he should
give back the partnership assets he used to purchase the speedboat.
GENERAL FEATURES OF A
PARTNERSHIP
LC 11 to
LC 12
73. 3. Unlimited liability
Even though a partnership has separate legal existence,
partners are still liable for debts and obligations that
cannot be paid by partnership assets. Like in a sole
proprietorship, creditors and other parties can go after the
personal assets of the partners when partnership assets are
not enough to satisfy their claims. Creditors can claim the
deficiency from any of the partners or from all the
partners.
GENERAL FEATURES OF A
PARTNERSHIP
LC 11 to
LC 12
74. 4. Limited life
The life of a partnership can be easily ended through
partnership dissolution or liquidation. Partnership dissolution
occurs when one of the partners withdraws from the
partnership or if a new partner is admitted. Dissolution of a
partnership does not necessarily mean that the partnership will
cease to exist. Withdrawal and admission of partners are
normal occurrences in a partnership, and they only lead to the
formation of a new partnership. Partnership liquidation, on
the other hand, ends the operations of the partnership
GENERAL FEATURES OF A
PARTNERSHIP
LC 11 to
LC 12
75. 5. Co-ownership of partnership property
⮚ In the formation of a partnership, partners contribute
money, property, and industry into a common fund.
Once a partner has contributed his/her money and/or
property, it does not belong to him/her anymore. The
contributed money and property belong to the
partnership and the partners only have a proportionate
share of partnership assets.
GENERAL FEATURES OF A
PARTNERSHIP
LC 11 to
LC 12
76. 5. Co-ownership of partnership property
⮚ In the ABC Partnership, assume that Bart contributed a delivery van
valued at ₱500,000. Bart cannot subsequently claim that he is the
owner of the van. From the moment he contributed the delivery van
to the partnership, he only has a proportionate share of the asset.
Andre, Bart, and Charles became co-owners of the van. Profits (or
losses) of the partnership do not also belong to a specific partner. All
partners have a claim on a definite portion of the profits. The
distribution of the profits should follow a profit-sharing scheme
agreed upon during the formation of the partnership. If there is no
profit-sharing scheme, profits (or loss) are distributed according to
the original capital contributions of the partners.
GENERAL FEATURES OF A
PARTNERSHIP
LC 11 to
LC 12
77. 6. Partnership agreement
⮚ The definition provided by the law states that a partnership is a
contract. Contracts are perfected through oral or written agreement.
Thus, a partnership can be formed orally or in written form.
However, to protect the interests of all partners, it is ideal to form a
partnership in a written contract. This written contract is called the
articles of partnership, and it contains the following:
1. Name of the partnership
2. Location of the principal office of the partnership
3. The names, citizenship, and residence of the partners
4. Term for which the partnership is to exist
5. The purposes for which the partnership is formed
6. Original capital contributions of the partners
GENERAL FEATURES OF A
PARTNERSHIP
LC 11 to
LC 12
78. Advantages
⮚ Easier to create than a corporation
⮚ Better ability to acquire additional capital than sole
proprietorships
⮚ Larger pool of human capital than sole proprietorships
Disadvantages
⮚ Unlimited liability
⮚ Mutual agency
⮚ Limited life
ADVANTAGES AND DISADVANTAGES
OF A GENERAL PARTNERSHIP
LC 11 to
LC 12
79. “ an artificial being created by operation of law,
having the right of succession and the powers,
attributes, and properties expressly authorized
by law or incident to its existence.”
CORPORATION
LC 11 to
LC 12
80. This definition emphasizes four things about a corporation. These are:
1.A corporation is an artificial being. It means that it is an entity separate and
distinct from its owners.
2.A corporation is created by operation of law. Individuals cannot form a
corporation by themselves. The law must play a role in the formation of a
corporation.
3.A corporation has the right of succession. Ownership rights can be passed to
other persons through sale, donation, or any other mode of transfer.
4.The law is the source of the powers and attributes of a corporation. Being the
source, the law can likewise restrict the authority of corporations in performing
acts.
CORPORATION
LC 11 to
LC 12
81. 1. Separate legal existence.
Just like a partnership, a corporation is treated by law as an artificial being
separate and distinct from its owners. A corporation can enter into contracts and
transactions under its name. It can also perform acts that can be done by natural
persons except those that are purely personal in nature such as voting and
holding positions in public office.
GENERAL FEATURES OF A
CORPORATION
LC 11 to
LC 12
82. 2. Limited liability.
⮚ The personal assets of the stockholders of a
corporation are protected from the claims of
creditors and other outside parties. Thus, the
maximum loss that a stockholder can bear equals
his or her investment. Even if the corporation is
bankrupt or has unpaid claims due to accidents
and lawsuits, the stockholders cannot be
obligated to pay any deficiency.
GENERAL FEATURES OF A
CORPORATION
LC 11 to
LC 12
83. 3. Transferable ownership rights-
⮚ Ownership rights in a corporation are represented by
stocks. A stock is an intangible (i.e., no physical
form) asset evidencing a proportionate share in the
properties of a corporation. A stock is represented
by a stock certificate. If an individual has stocks of a
corporation, he or she is an owner of the company.
Stocks can be transferred to other persons through
sale, donation, or other modes of transfer
GENERAL FEATURES OF A
CORPORATION
LC 11 to
LC 12
84. 4. Virtually unlimited life-
⮚ A corporation shall exist for a period not existing 50
years from the date of its formation. The term of a
corporation may, however, be extended for periods not
existing 50 years. This gives corporations virtually
unlimited life. As long as the stockholders want to
continue business operations, they are allowed to extend
the life of the corporation. There is no limit to the
number of extensions a corporation can avail of. A
corporation is also not affected by the withdrawal, death,
and admission of stockholders.
GENERAL FEATURES OF A
CORPORATION
LC 11 to
LC 12
85. 5. Corporation management.
⮚ The management structure of a corporation is more
complex than that of the other forms of business
organizations.
⮚ Stockholders are the owners of a corporation. They
may elect a board of directors to manage the
corporation. The board of directors represents the
interest of the stockholders and they are responsible
for creating operating policies for the company.
GENERAL FEATURES OF A
CORPORATION
LC 11 to
LC 12
86. 6. Government Regulations.
⮚ Corporations are subject to stricter government regulation
than sole proprietorships and partnerships. Being major
contributors to the income of the whole economy, the
operations of corporations are closely monitored by the
government.
⮚ The bankruptcy of a large corporation can cause the whole
economy to also spiral downwards. Government
regulations are designed not only for the protection of
public interest, but also for the stockholders’ as well.
GENERAL FEATURES OF A
CORPORATION
LC 11 to
LC 12
87. 7. Double Taxation.
⮚ The income of a corporation is taxed on the
corporate level and the individual level.
⮚ In a corporation, the income is already taxed
before being distributed to the stockholders.
Once a stockholder receives his or her share
of the income, it is included in his or her tax
return and will be taxed for the second time.
GENERAL FEATURES OF A
CORPORATION
LC 11 to
LC 12
88. 8. Dividends.
⮚ The corporation is not required to distribute to stockholders the
income it generated from operations. The stockholders of a
corporation will only be entitled to receive a share of the
income once the board of directors approves the distribution.
The income distributed to stockholders is called dividends.
⮚ Dividends may be in the form of cash, stock, or property.
⮚ Even though the approval of the board of directors is necessary
before income can be distributed, dividends are given to the
stockholders on a regular basis to keep them happy. If
stockholders do not regularly receive dividends, they tend to
become dissatisfied and sell their stocks.
GENERAL FEATURES OF A
CORPORATION
LC 11 to
LC 12
89. 8. Dividends.
⮚ For example:
⮚ If the board of directors declared cash dividends of ₱2 per share of
stock, an individual holding 1 000 shares of stock will receive ₱2 000.
⮚ Stock dividends are distribution of income in the form of additional
stocks. It is normally stated in percentage terms. For example, if the
board of directors declared a 10% stock dividend, an individual holding
1000 shares of stock will receive an additional 100 stocks free of charge.
⮚ A property dividend enables the stockholders to receive a certain value
of the property of the company for every share of stock held. For
example, if the board of directors declared a property dividend of one
unit of inventory for every share of stock, an individual holding 1 000
shares of stock will receive 1 000 units of inventory.
GENERAL FEATURES OF A
CORPORATION
LC 11 to
LC 12
90. Advantages
⮚ Ability to acquire additional capital
⮚ Transferable ownership rights
⮚ Limited liability of stockholders
⮚ Virtually unlimited life
⮚ Large pool of human capital
Disadvantages
⮚ Heavily regulated by the government
⮚ Double taxation
⮚ Not easy to form
⮚ More expensive to form than sole proprietorships and partnerships
ADVANTAGES AND DISADVANTAGES
OF A CORPORATION
LC 11 to
LC 12
91. “A cooperative is a duly registered association of
persons, with a common bond of interest, who
have voluntarily joined together to achieve a
lawful common social or economic end, making
equitable contributions to the capital required
and accepting a fair share of the risks and
benefits of the undertaking in accordance with
universally accepted cooperative principles.”
COOPERATIVES
LC 11 to
LC 12
92. From this, we can see that a cooperative
is an association of individuals who share
a common goal. Membership in a
cooperative shall be voluntary and
available to all individuals regardless of
their social, political, racial or religious
backgrounds and beliefs
COOPERATIVES
LC 11 to
LC 12
93. The primary objective of a cooperative is to
provide goods and services to its members and
enable them to attain increased income and
savings.
COOPERATIVES
LC 11 to
LC 12
94. Other characteristics of a cooperative include the following:
⮚ It can sue and be sued under its own name.
⮚ It has the right of succession.
⮚ Members of a cooperative are subject to limited liability.
⮚ It shall exist for a period not exceeding 50 years from the date
of formation. The cooperative term may be extended for
periods not exceeding 50 years.
⮚ A cooperative has its set of board of directors.
⮚ Income of a cooperative (called net surplus) belongs to its
members.
COOPERATIVES
LC 11 to
LC 12
95. A cooperative may be formed by at least 15
persons for any of the following purposes:
1. To encourage thrift and savings mobilization among the members
2. To generate funds and extend credit to the members for productive and
provident purposes
3. To encourage among members systematic production and marketing
4. To provide goods and services and other requirements to the members
5. To develop expertise and skills among its members
6. To acquire lands and provide housing benefits for the members
7. To insure against losses of the members
8. To promote and advance the economic, social, and educational status of
the members.
COOPERATIVES
LC 11 to
LC 12
96. CHAPTER 5 : TYPES OF BUSINESS
ACCORDING TO
ACTIVITIES
97. A business is an organization that converts inputs or resources such
as material, labor, and overhead into outputs which are usually
either goods or services.
There are three major types of business. These are:
1. Service companies
2. Merchandising companies
3. Manufacturing companies
SERVICE COMPANIES
LC 13 &
LC 14
98. ⮚ Are firms that generally use their employees to provide intangible
products or services to customers, including professional skills, advice,
expertise, and other related products. The primary source of revenues
of service companies is the performance of services, often referred to
as service revenues.
⮚ A law firm is an example of a service company as it provides legal
advice to its clients. A school is also considered a service company as it
relies heavily on its employees (i.e., teachers) to educate its students. A
bus company is a service company though it invests heavily on
equipment which are used to perform transportation services. Other
examples of service companies are banks, accounting firms, and
hospitals.
SERVICE COMPANIES
LC 13 &
LC 14
99. ⮚ For service companies, the major phases of their operating cycle
include paying out money for employees and other operating
expenses, performing the services, and collecting cash payments
from customers.
⮚ Operating cycle is the time it takes for a company to create
products, sell these products, and collect cash payments from
customers.
SERVICE COMPANIES
LC 13 &
LC 14
100. ⮚ To illustrate, consider FDG & Co. which is an accounting firm.
In order to conduct its business, it hires its employees who are
highly skilled accountants and who will carry out engagements
with the firm’s clients. FDG & Co. makes sure that its employees
are compensated properly and are given adequate trainings.
These employees perform audit, consulting, and tax services for
the clients. Consequently, the clients pay for the services
rendered. The operating cycle ends when FDG & Co. receives
the payment in the form of cash.
SERVICE COMPANIES
LC 13 &
LC 14
102. SERVICE COMPANIES
LC 13 &
LC 14
Operating Cycle of Service Companies
One of the advantages of a service company over the other types of business
is the absence of inventory or tangible goods held by the company. Holding
inventory entails proper management and control measures which make it
costly. Moreover, because service companies produce intangible products,
they do not require production facilities and that frees up cash for other
important business matters.
103. SERVICE COMPANIES
LC 13 &
LC 14
These companies rely on human capital, one drawback to
service companies is the inability to standardize services
as services performed vary from one client to another. And
in order to ensure that the services given to customers are
of high quality, constant evaluation and trainings are
administered. With human capital being limited, trainings
and employment benefits are also vital to attract, retain,
and motivate highly skilled employees.
104. MERCHANDISING COMPANIES
LC 13 &
LC 14
⮚ Merchandising companies sell tangible products. This
type of business buys finished or almost finished goods
from their suppliers and resells the same to customers.
⮚ Merchandising companies primarily earn revenues from
the sale of the goods or merchandise, also known as
sales revenue or sales.
105. MERCHANDISING COMPANIES
LC 13 &
LC 14
Two types of merchandising companies ‒ retailers and
wholesalers.
⮚ A merchandising company that sells goods directly to
customers is called a retailer.
⮚ A wholesaler is a merchandising company that sells
goods to retailers.
⮚ For instance, the retailer National Book Store buys
school supplies from the wholesaler Pilot.
107. MERCHANDISING COMPANIES
LC 13 &
LC 14
The operating cycle of a merchandising company
⮚ is typically longer than that of a service company.
⮚ It starts with the purchase of goods to be held for resale,
also known as inventory. The company eventually sells
the inventory to customers. The cycle ends with the
receipt of cash payments. As you can see, the purchase
of inventory and its subsequent sale lengthen the cycle.
108. MERCHANDISING COMPANIES
LC 13 &
LC 14
The operating cycle of a merchandising company
As an example, National Book Store buys school supplies from various
suppliers such as Pilot, Cattleya, Crayola, and 3M. These school
supplies which are inventory of the company are put on the store racks
and are sold to customers afterwards. The cycle ends when the cash
payments are received by the company.
⮚ .
109. MANUFACTURING COMPANIES
LC 13 &
LC 14
As the name suggests, manufacturers create their own
products. They use raw materials, components, or parts
which are processed using machines, computers, and labor
to produce finished goods.
⮚ Manufacturers typically employ large-scale production
which is done in manufacturing plants. Similar to
merchandising companies, they earn revenues primarily
from the sale of manufactured products.
110. MANUFACTURING COMPANIES
LC 13 &
LC 14
The products of manufacturing companies can be sold
directly to consumers, retailers, and other manufacturers.
For example, Toyota builds cars and sells them to
customers through their dealers nationwide. Meanwhile,
Unilever manufactures its products like Dove and Cream
Silk and sells them to retailers such as SM and other
supermarkets. 3M manufactures adhesives which are
bought and used by aircraft manufacturers in creating their
own products.
111. MANUFACTURING COMPANIES
LC 13 &
LC 14
Since a manufacturing company produces its own
products, its operating cycle generally has the longest
period compared to service and merchandising.
The cycle has an additional phase which is the production
of goods. These goods are also held as inventory and later
sold to its customers. Likewise, the operating cycle of a
manufacturing company ends with the collection of cash
payments.
112. MANUFACTURING COMPANIES
LC 13 &
LC 14
As an illustration, imagine Nike Inc. which is a leading shoe
manufacturer. It owns more than 600 factories across the
globe where Nike shoes are made. It acquires its raw
materials from various suppliers, hires more than a million
factory workers, and invests heavily on technology. Using
all these inputs, Nike shoes are manufactured and ensured
that they reach quality standards. After passing the
standards, the shoes are shipped to distributors and
retailers who will sell the products to consumers. In the early
2015, Nike Inc. has a 135- day operating cycle which is comprised
of 95-day average inventory processing period and 40-day
average receivable collection period.
114. CHAPTER 6 : ACCOUNTING
CONCEPTS
AND PRINCIPLES
115. 1. Accrual accounting
2. Matching principle
3. Use of judgment and estimates
4. Prudence
5. Substance over form
6. Going concern assumption
7. Accounting entity assumption
8. Time period assumption
9. Generally Accepted Accounting Principles (GAAP)
10.International Financial Reporting Standards (IFRS) and
ACCOUNTING CONCEPTS AND
PRINCIPLES
LC 15 &
LC 16
116. ⮚ Financial statements become more comparable and more useful
to users if these concepts, principles, and assumptions are
followed by businesses. We can look at these as a set of rules
that govern the accounting process.
⮚ Accounting concepts, principles, and assumptions serve as the
foundation of accounting in order to avoid misunderstanding
and enhance the understanding and usefulness of the financial
statements.
ACCOUNTING CONCEPTS AND
PRINCIPLES
LC 15 &
LC 16
117. ⮚“The effects of business transactions should be
recognized in the period in which they occurred.
Income should be recognized in the period when it is
earned regardless of when the payment is received.
Expenses should be recognized in the period when it is
incurred regardless of when the expenses are paid.”
ACCRUAL ACCOUNTING
LC 15 &
LC 16
118. ⮚ Suppose Andrew, a budding entrepreneur, established a
merchandising business that sells ready-to-wear clothes to
different ukay-ukay stores in the country. The income from
Andrew’s business primarily comes from selling goods to
customers. Sales to customers can be for cash or on credit. If the
business was able to sell goods for cash, this will be recorded in
the accounting records of the company. On the other hand, if
the goods were sold on credit, the transaction should still be
recorded in the accounting records as accounts receivable.
ACCRUAL ACCOUNTING
LC 15 &
LC 16
119. ⮚ An accountant does not have to wait for cash to be received or
for cash to be paid before he or she records a business
transaction. Because of accrual accounting, use of accounts such
as accounts receivable, accounts payable, prepaid expenses,
accrued expenses, deferred income, and accrued income are
possible.
ACCRUAL ACCOUNTING
LC 15 &
LC 16
120. The opposite of accrual accounting is the cash basis of
accounting. Under the cash basis of accounting, income is
recognized when cash is received and expenses are
recognized when cash is paid. As its name implies, under
the cash basis of accounting the receipt and/ or payment
of cash is a requisite before transactions are recorded in
the accounting records of a company.
ACCRUAL ACCOUNTING
LC 15 &
LC 16
121. ⮚ Under the matching principle, expenses are
recognized in the same period as the related revenue.
Revenues of a business always come with expenses..
⮚ The matching principle states that related revenues and
expenses should always go together. In other words, if
the revenues are recorded in period 1, the related
expenses should also be recorded in period 1.
MATCHING PRINCIPLE
LC 15 &
LC 16
122. ⮚ There is a cause-and-effect relationship between
revenues and expenses. If this relationship does not
exist between revenues and expenses, the expenses
should be recognized immediately in the accounting
records of the company. Advertising and marketing
expenses are the most common examples of this kind
of expense. Since the related benefit that is expected to
be derived from advertising and marketing cannot be
measured reliably, these expenses are recognized
immediately.
MATCHING PRINCIPLE
LC 15 &
LC 16
123. ⮚ For example, Rudy, a car salesman who works for Honda, has a monthly
salary of ₱30 000. Aside from that, he receives a commission of 5% for all
the sales he made for the month. During the month of December, he was
able to sell 10 cars for a total amount of ₱12M. The ₱12M is recorded as
sales of the company. By selling 10 cars for the month, Rudy is entitled to
receive ₱630 000 (i.e., ₱30 000 monthly salary plus ₱600 000 commission).
How much is to be recognized as business expense for December? The
monthly salary of Rudy plus his commissions are expenses of the company.
By the end of the month, the salary of Rudy and his commissions are still
not yet paid. Under the matching principle, the ₱630 000 will be recorded as
an expense in December even though it is not yet paid since it is related to
the ₱12M in revenues. Without the matching principle, the ₱630 000 may be
recorded as an expense in January when the payment to Rudy is made.
MATCHING PRINCIPLE
LC 15 &
LC 16
124. ⮚ How much is to be recognized as business expense for December?
⮚ The monthly salary of Rudy plus his commissions are expenses
of the company. By the end of the month, the salary of Rudy
and his commissions are still not yet paid. Under the matching
principle, the ₱630 000 will be recorded as an expense in
December even though it is not yet paid since it is related to the
₱12M in revenues. Without the matching principle, the ₱630
000 may be recorded as an expense in January when the
payment to Rudy is made.
MATCHING PRINCIPLE
LC 15 &
LC 16
125. ⮚ Accounting estimates are approximations made by accountants or the
management in the preparation of financial statements. The use of
reasonable estimates is an essential part of the preparation of financial
statements and does not undermine their reliability.
⮚ Some items in a company’s accounting records such as cash; property, plant,
and equipment (PPE); and accounts payable can be measured precisely. For
these items that can be measured with precision, the use of estimates is not
required.
USE OF JUDGMENT AND
ESTIMATES
LC 15 &
LC 16
126. ⮚ Warranty expense is an item in the accounting records that
requires the use of estimates. A warranty is a guarantee made by
the seller to the buyer promising to repair or replace the thing
sold if necessary within a specified period of time. When a seller
sells goods, there are revenues generated that are recorded in
the company’s accounting records.
⮚ According to the matching principle, all related expenses should
also be recorded in the same period the revenues are
recognized. Warranty expense is related to the revenues
generated from the sale of goods. The problem is what amount
of warranty the company should recognize in the accounting
records.
USE OF JUDGMENT AND
ESTIMATES
LC 15 &
LC 16
127. ⮚ A company is not entirely sure when warranties will be performed by the
company. Because of this, the warranty expense in a company’s accounting
records is usually estimated based on historical data.
⮚ However, the use of accounting estimates cannot be abused by an entity by
purposely overestimating expenses. Some companies overestimate expenses
to decrease net income and decrease the taxes payable. Judgment used in
making accounting estimates should be backed up by a reasonable basis. It is
more desirable to use less judgment in the accounting process because the
use of judgment leads to more subjective financial statements.
USE OF JUDGMENT AND
ESTIMATES
LC 15 &
LC 16
128. ⮚ Prudence in the accounting sense is also called conservatism.
⮚ When applying the concept of prudence, an accountant makes
sure that income and assets are not overstated and liabilities and
expenses are not overstated.
PRUDENCE
LC 15 &
LC 16
129. ⮚ In the simplest words, conservatism means in case of doubt,
record any loss and do not record any gain.”
⮚ For example, when an accountant is unsure whether or not to
recognize an expense, the concept of prudence states that he or
she should recognize it in the accounting records. On the other
hand, if an accountant is unsure whether or not to recognize
income, prudence states that he or she should not recognize it.
PRUDENCE
LC 15 &
LC 16
130. ⮚ Information presented in the financial statements of a company
should truthfully and faithfully represent the financial condition
and financial performance of the company.
⮚ For this to be possible, an accountant should look at the
substance of every financial transaction rather than its legal
form.
SUBSTANCE OVER FORM
LC 15 &
LC 16
131. ⮚ Most of the time, the substance of a transaction does not differ
from its legal form. An example is the sale of goods. In this
transaction, there can be no doubt that the substance and legal
form of the transaction is a sale.
⮚ A transaction where the substance differs from the legal form is
a lease. In a lease, the lessor allows the lessee to use the
former’s property in exchange for a periodic fee. However,
when ownership of the property transfers to the lessee at the
end of the lease, the substance differs from the legal form.
SUBSTANCE OVER FORM
LC 15 &
LC 16
132. ⮚ In this case, the transaction is really a sale of property with
instalment payments instead of a lease. The lessee will record an
asset and a liability in his or her accounting records instead of
recognizing an expense.
⮚ When the substance differs from the legal form, follow the
substance of the transaction. In the example given, the
substance is a sale of property in instalment payments while the
legal form is a lease. The transaction should be treated as a sale
of property in instalments since substance prevails over legal
form.
⮚ .
SUBSTANCE OVER FORM
LC 15 &
LC 16
133. ⮚ States that the operations of a business will continue indefinitely
into the future. This means that the operations of a business
will not stop in the near future and it will not be forced to
liquidate its assets to pay off its liabilities. The going concern
assumption allows accountants to defer recognition of expenses
in the future
⮚ .
GOING CONCERN
ASSUMPTION
LC 15 &
LC 16
134. ⮚ For example, Company A rents a building for ₱100 000 per month. On
January 1, 2016, the company paid the rent for two years in the amount of
₱2 400 000. Under the going concern assumption, the company can
recognize the part of the ₱2 400 000 that is not yet incurred. On January 1,
2016, the company has not yet used the building but they already paid the
rent. In this case, the accountant can record an asset (i.e., prepaid expense)
instead of recognizing an expense immediately. If the entity is not a going
concern, there is no point recognizing the payment as an asset since the
company will not derive all benefits from it. A company that is not a going
concern will halt operations in the near future, so the payment of ₱2 400 000
will be recognized wholly as an expense instead of recording an asset.
⮚ .
GOING CONCERN
ASSUMPTION
LC 15 &
LC 16
135. ⮚ However, if there is substantial doubt about the ability of a
company to continue as a going concern, the company can
abandon this assumption. The following items are evidences that a
company is not a going concern:
⮚ 1. The results of operations consistently show losses
⮚ 2. Inability to pay the obligations of the company in time
⮚ 3. Loan defaults
⮚ 4. Suppliers do not sell on credit to the company
⮚ 5. Legal proceedings against the company
⮚ .
GOING CONCERN
ASSUMPTION
LC 15 &
LC 16
136. ⮚ The business is separate and distinct from the owners,
managers, and employees operating the business. Likewise, if a
person owns multiple businesses, each business is distinct from
all the others. This means that if a person has three businesses,
then each business will keep its own accounting records. The
assets and liabilities of the three businesses should not be mixed
with one another.
ACCOUNTING ENTITY
ASSUMPTION
LC 15 &
LC 16
137. ⮚ The main purpose of the accounting entity assumption is for
the fair presentation of the financial statements of the company.
If the personal transactions of owners, managers, and
employees are recognized in the accounting records of the
business, the financial statements will not accurately represent
the results of operations of the business.
ACCOUNTING ENTITY
ASSUMPTION
LC 15 &
LC 16
138. ⮚ States that the indefinite life of a company can be divided into
periods of equal length for the preparation of financial reports.
Normally, the periods span for one year.
⮚ Every year, most businesses produce financial reports for the
benefit of the users of accounting information.
⮚ Still, there are businesses that produce financial reports on
periods less than or in excess of one year. The frequency of
financial reporting also depends on the normal operating cycle
of a business.
TIME PERIOD ASSUMPTION
LC 15 &
LC 16
139. ⮚ Users of the accounting information of a company need
periodic reports to enable them to make economic decisions.
An owner or stockholder needs reports consistently to decide if
he or she will still keep his or her ownership interest in the
company. A supplier needs reports consistently to decide if it is
still beneficial to transact with the company. This is where the
time period assumption comes into play.
TIME PERIOD ASSUMPTION
LC 15 &
LC 16
140. ⮚ The purpose of financial statements is to show the overall
results of the operations of a company. However, the final and
comprehensive report of the results of company operations
cannot be produced until the company is at the end of its life
(i.e., after liquidation).
⮚ The accounting period of a business may be a calendar year or a
fiscal year.
TIME PERIOD ASSUMPTION
LC 15 &
LC 16
141. ⮚ The Generally Accepted Accounting Principles (GAAP)
consists of accounting principles, standards, rules, and
guidelines that companies follow to achieve consistency and
comparability in their financial statements.
⮚ Since the GAAP enhances the consistency and comparability of
a company’s financial statements, it will be easier for external
users to examine if the company is doing well currently or in
relation to its past performance.
GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (GAAP)
LC 15 &
LC 16
142. ⮚ Simultaneously, GAAP also helps management in
understanding trends persistent in the company. Management
can also compare past and current performance to check the
strong and weak points of company operations.
⮚ The formulation, development, and modification of the GAAP
go through a rigorous process involving professional judgement
and research.
GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (GAAP)
LC 15 &
LC 16
143. ⮚ Due to the rapid advancement of technology, there are new
kinds of transactions encountered today that were not present
in the past. The standards followed by accountants in the
practice of their profession shouldalso adapt with these
changes. Thus, the GAAP is also being developed and
improved continuously.
GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (GAAP)
LC 15 &
LC 16
144. ⮚ The International Financial Reporting Standards (IFRS) are
pronouncements issued by the International Accounting
Standards Board (IASB) that intend to enhance the
comparability of the financial statements of all companies
around the world. In light of globalization, the IFRS will
provide a way for users of accounting information to easily
understand the results of operations of companies all around
the globe.
INTERNATIONAL FINANCIAL
REPORTING STANDARDS (IFRS)
LC 15 &
LC 16
145. ⮚ In the past, the function of the IASB is performed by the
International Accounting Standards Committee (IASC). The
pronouncements of the IASC are called International
Accounting Standards (IAS). Up to this day, the IASB still
adheres to the IAS in addition to their own pronouncements—
the IFRS.
INTERNATIONAL FINANCIAL
REPORTING STANDARDS (IFRS)
LC 15 &
LC 16
146. ⮚ In the Philippines, the development of accounting standards
that will be used in the country consider the pronouncements
issued by the USA Financial Accounting Standards Board
(FASB) and the IASB (Valix et al. 2013). The Philippines
follows the standards of both the IAS and the IFRS. In
contrast, USA follows guidelines provided by the GAAP.
⮚ The Philippines are fully compliant with the IFRS effective
January 2005.
INTERNATIONAL FINANCIAL
REPORTING STANDARDS (IFRS)
LC 15 &
LC 16
147. ⮚ The following factors are considered in the decision to adapt
the IFRS (Valix et al. 2013):
1. Philippine organizations’ support of international accounting standards
2. Increasing internalization of businesses which greatly calls for a common
language for financial reporting
3. Improvement of international accounting standards or removal of free
choices of accounting treatments
4. International accounting standards being recognized by the World Bank,
Asian Development Bank, and World Trade Organization
INTERNATIONAL FINANCIAL
REPORTING STANDARDS (IFRS)
LC 15 &
LC 16
148. ⮚ The Philippine Financial Reporting Standards Council (PFRSC) issues
standards to be used in the Philippines in the form of Philippine Financial
Reporting Standards (PFRS).
⮚ The PFRS include all of the following:
⮚ 1. Philippine Financial Reporting Standards (PFRS) which corresponds to
International Financial Reporting Standards (IFRS)
⮚ 2. Philippine Accounting Standards (PAS) which corresponds to
International Accounting Standards (IAS)
⮚ 3. Interpretations of accounting standards issued by the Philippine
Interpretations Committee in accordance with interpretations of the IFRIC
and the Standing Interpretations Committee
PHILIPPINE FINANCIAL
REPORTING STANDARDS (PFRS)
LC 15 &
LC 16
