FABM 1 Module 1 and 2

Introduction to Accounting
By
Rexmar Christian L. Bernardo, CPA,MBA

What is accounting?
Accounting, as defined by the Committee on Terminology, American
Institute of Accountants (AICPA), is an art of recording, classifying, summarizing in
a significant manner and in terms of money, transactions and events, which are in
part, at least, of financial character and interpreting the results thereof.
Accounting vs. Bookkeeping
Accounting, also known as double-entry bookkeeping, (FRA LUCA
PACIOLI) is almost the same as Bookkeeping. However, bookkeeping is a skill that
allows for the recording, classifying, and summarizing of business transactions,
while accounting – aside from those activities mentioned – also covers the
interpretation of the said transactions. These 4 activities: recording, classifying,
summarizing, and interpreting, are what we call the four phases of accounting.

Branches of Accounting

Financial Accounting
Financial accounting involves recording and classifying business transactions, and
preparing and presenting financial statements to be used by internal and external
users. Strict compliance with Generally Accepted Accounting Principles (GAAP) is
observed in the preparation of financial statements. Processing of Historical Data
is the primary concerned of Financial Accounting.
Management Accounting
Managerial or management accounting focuses on providing information for use
by internal users, the management. It involves financial analysis, cost analysis,
budgeting and forecasting, evaluation of business decisions, and similar areas.
This Branch deals with the needs of the management rather than strict
compliance with GAAP.
Government Accounting
Government Accounting encompasses the process of analyzing, classifying,
summarizing and communicating all transactions involved in the receipts and
disbursement of all government funds and properties, and interpreting the results
thereof.
Auditing
Auditing is the process of examining an entity’s accounting records, as well as
physical inspection of its assets. It is performed by a Certified Public Accountant
(CPA) whom can express an opinion on the fairness of the entity’s financial
statements.
Cost Accounting
Cost Accounting is considered as a subset of management accounting. It refers to
the recording, presentation, and analysis of manufacturing costs. Manufacturing
businesses use cost accounting since they have the most complicated costing
process.
Academe
Accounting education or academe includes accountants who pursue as
instructors, researchers, authors and reviewers.

Basic Accounting Principles

What are the Generally Accepted Accounting Principles (GAAP)
GAAP is composed of the accounting principles, standards and procedures
that an enterprise should follow in preparing financial statements. It is generally
accepted by members of the accounting profession by agreement based on
experience, reason, custom, usage and practical necessity. It is like a law that
must be adhered to improve the clarity of the communication of a financial data
Entity principle
When we say business entity, we refer to the specific business enterprise,
sole proprietorship, partnership or corporation. In this principle, it is assumed
that the business owners or managers are separate from the business enterprise.
Therefore, the transactions of the owners should not be combined with the
transactions of the enterprise. This is for fair presentation of financial statements.
Example: If Mr. ABC invests money to put up a Repair Shop, it will no longer be his
personal money but a fund to be used by the Repair Shop for its operation.

Matching principle
This principle requires that those costs and expenses incurred in earning
revenue should be recorded and reported in the same period. This means that
revenues and expenses that result directly from the same transactions and events
should be recognized within one accounting period. Example: If the earnings of
the repair shop of Mr. ABC from the sale of goods are reported in the financial
statements for 2016, the sales commissions of the salesman and other expenses
related to that sale should also be reported in the same year.

Accrual basis of Accounting

It means that the income is recognized when they are earned regardless of
when they are received; and the expense is recognized when they are incurred
regardless of when they are paid. In accrual basis of accounting, we recognize the
effects of transactions and other events from the time they happen and not when
cash or its equivalents is received or paid. Recording and reporting is done at the
time they happen. Example: If Mr. ABC repaired an air-conditioning (AC) unit on
June 5 but was only paid on June 8, under the accrual basis, income should be
recognized on June 5, the date the income was earned for the repair of the AC,
and not on June 8 when the cash is collected by Mr. ABC.
Stable monetary unit
This principle has two aspects, the quantifiability and stability of peso. The
quantifiability aspect means that we must record the assets, liabilities, capital,
income, and expense in terms of unit of measure which is the peso in the
Philippines. In stability of the peso, we assume that the purchasing power of the
peso is stable and constant therefore, we may ignore its instability since it is not
significant.
Periodicity (Time period concept)
This principle requires that life of the enterprise be subdivided into time
periods or accounting periods which may be a calendar year or fiscal year. A
calendar year is a twelve-month period which starts from 01 January and ends on
31 December, while a fiscal year is any twelve-month period starting from any
month other than 01 January.
Going concern
Taking into consideration the normal business operation, it is presumed
that business will continue to operate indefinitely. Meaning, preparation of
financial statements is based on the assumption that a business will continue to
operate in time. This is the reason why assets are recorded at cost and market
values are not considered. Example: Mr. ABC has several machineries which are
used in operating his repair shop. Said machineries will be reported in the
financial statements under the going concern basis, as part of its assets. Since we
assume that Mr. ABC’s repair shop will continue to operate, these machineries
will continue to provide him economic benefits. If Mr. ABC ceases operation, the
machineries will no longer have any value, hence, would not be treated as assets.

Forms of Business Organizations

We need to understand that since Accounting is the language of business,
we need to know the different forms and types of business.
Sole or single proprietorship
 This is a type of business which is owned by only one person. Usually a sole
proprietor (owner of the business), is also the manager or boss of his own
business.
Advantages:
 Formation is easy because fewer documents are needed in opening this type of
business compared to a partnership or corporation.
 It is easy to operate since most of this type of business is small.
 It is easy to manage since the owner makes the decision himself.
 Lesser tax to pay unlike other types of businesses.
 The proprietor alone enjoys the profits gained by the business.

Disadvantages:
 The sole proprietor has to shoulder all the risks and losses.
 The sole proprietor has no one to get advice from or opinion regarding business
operations.
 The sole proprietor has unlimited liability for any debt of the business which
may extend up to his personal properties.
 The sole proprietor has limited ability to raise funds for his business as it grows.

Partnership
By the contract of partnership, two or more people join together to
contribute money, property or industry for purposes of dividing the profits (or
loss) among themselves.
Advantages:
 Formation is easier than that of the corporation because of minimal regulatory
requirements.
 Management is divided among partners, thus less burden to each of the
partners.
 More capital can be contributed by the partners.
 It is exempted from paying corporate income taxes.
Disadvantages:
 Limited life. When a partner withdraws due to incapacitation, bankruptcy,
death, or the addition of a new partner, the partnership is dissolved.
 Unlimited liability of partners. The partner’s liability extends up to their
personal properties in case of insolvency.
 Joint liability. Each of the partners can bind the partnership to contracts which
make all partners jointly liable.
Corporation
It is composed of five to fifteen people. It is organized by operation of the
law and considered the most complex form of a business organization.
Advantages:
 There is a board of directors who makes decisions for the corporation.
 It has the capacity to raise more capital.
 It can exist for a period not more than 50 years, subject to renewal.
 It has limited liability. This means creditors cannot go after their personal
property in case of bankruptcy.
Disadvantages:
 It is costly to form and manage a corporation.
 The government has greater scrutiny, regulation, control and supervision over
the corporation.
 It is more complex to manage a corporation compared to partnership and sole
proprietorship.
 It has limited powers as stated in the Corporation Code.
 It is subject to higher income tax.

Types of Business According to Activities

Businesses usually undertake three activities: investing, financing and
operating. Operating activities refer to the undertakings of the business that
generate additional resources for the firm. Operating activities involve using the
firm’s resources to generate goods and services for sale at a profit. There are
three types of business operations: service, merchandising, and manufacturing.
As a refresher from the first module, let us expound further on these.

Service
A service business is involved in selling services. This is a business that
generates income by providing services instead of selling physical products. A
doctor or a teacher practicing their professions, a day-care center, or a big
accounting firms like SGV & Co and Ernst & Young are all engaged in service
businesses.
Advantages:  No Production Facilities  Absence of inventory
Disadvantages:  Maintain Human Capital  Difficulty to standardize services

Merchandising
A business that buys inventory that it will resell in retail or wholesale,
generally for a higher price than they were purchased, is a merchandising
business. A merchandising business ranges from a fruit-stand store to an online
retailer like Lazada or OLX, or a bookstore like National Bookstore or Fully-
Booked.
Advantages:  Less conversion, time and effort  Visible Products
Disadvantages:  Inventory Management
Manufacturing
A manufacturing business usually does activities that converts raw materials into
finished products, and sells this to other firms or to individuals. This type of
business incurs overhead costs aside from the wages and materials used in the
production of goods. Examples include: San Miguel Corporation, Ayala Land, and
Samsung.
Advantages:  Visible Products  Quality Control
Disadvantages:  High manufacturing costs  Quality control cost  Need of
facilities in production  Inventory Management
Exercise 1.
a. Give the definition of accounting (Make sure to memorize it because in our
every session I will call someone to state the definition of accounting)
b. Who are the users of the accounting information? (You can research it thru
internet or books)

Exercise 2. True or False

Instruction. Before each statement, write TRUE if the statement is correct or
FALSE if the statement is incorrect.
1. Internal users are those who own and/or manage and control the business
entity.
2. The external users of financial statements include present and potential
investors, employees, lenders, suppliers and other trade creditors,
customers, government and their agencies, and the public.
3. Board of Directors is an example of external users.
4. Investors need accounting information to assess their return on
investments.
5. Employees use the financial statements of their customers to determine
the continuity of the latter’s business.
6. Accounting is often referred to as a language of business.
7. Bookkeeping and accounting are synonymous.
8. All responsibilities and business decisions fall on the shoulder of the sole
proprietorship.
9. Sole proprietor cannot be held personally liable for the debts and
obligations of the business.
10. Partnership is the most stable form of business among other types of
business organization.

Exercise 3. MULTIPLE CHOICE

Instruction: Encircle the letter corresponding to the correct answer for each of the
questions provided below.
1. Which of the following statements regarding partnership is not valid?
a. Partnership may be dissolved at any time by order of law or by decision
made by partners.
b. Contributions made by the partners are owned by the partnership.
c. A partnership has separate legal entity from its owners.
d. In partnership, the industrial partner is not entitled for a share in profit.

2. It is the easiest and simplest form of business organization.

a. Cooperative
b. Sole proprietorship
c. Partnership
d. Corporation

3. The main disadvantage of a partnership is

a. Unlimited liabilities of the partners
b. Disagreements and disputes among partners
c. Shared management
d. Conflict of ideas

4. Which of the following is an advantage of a sole proprietorship?

a. Unlimited liability
b. Ease of starting the business
c. Expensive cost of registration
d. Less stable and easy to dissolve

5. It is a form of business organization owned by its shareholders

a. Cooperative
b. Sole Proprietorship
c. Partnership
d. Corporation