HANDOUT IN FUNDAMENTALS OF ACCOUNTING, BUSINESS AND MANAGEMENT (FABM) 1

CHAPTER 1: INTRODUCTION TO ACCOUNTING

• Definition, Nature, and Functions of Accounting

• Users of Accounting Information
• Forms of Business Organizations
• Types of Business According to Activities
• Basic Accounting Concepts and Principles

LEARNING OBJECTIVES

At the end of this chapter, you should be able to:

1. define accounting;
2. describe the nature of accounting;
3. explain the functions of accounting;
4. explain why accounting is called the language of business;
5. Identify the users of accounting information;
6. differentiate the forms of business organization;
7. name some business entities operating in your community, identify the form of
business organization they belong and the type of activities they have; and
8. explain the varied accounting concepts and principles

LESSON 1: DEFINITION, NATURE, AND FUNCTIONS OF ACCOUNTING.

What is Accounting?
Accounting has been defined by several accounting bodies in different forms. The definitions
given highlight the nature and functions of accounting:
1. The Accounting Standards Council (ASC) in its old Statement of Financial Accounting
Standards (SFAS) defines accounting as follows:

“Accounting is a service activity. Its function is to provide quantitative information,

primarily financial in nature, about economic entities, that is intended to be useful
in making economic decisions.”

2. The Committee on Accounting Terminology of the American Institute of Certified Public

Accounting (AICPA) defines accounting as follows:

“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 financial character, and interpreting the results thereof.”

These two definitions of accounting are in agreement that accounting is a tool used to
communicate results of business operation.
Accounting is also called the language of business. Actually, this is the shortest definition of
accounting.
The business can effectively communicate to all interested users, information about the
business operation through accounting.

The following information about the business are usually communicated:

1. The result of its financial operation; that is, whether the business is profitable or not.
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 2. The status of its financial condition; that is, whether the business is stable and has the
capacity to settle financial obligations.
3. The cash inflows and outflows during the period; that is, where the business obtains its cash
and where it spends said cash.
4. Other information that are probable to happen in the future.

Accounting as the Language of Business (with illustration of the Business Entity Concept)
In accounting, the owner and the business are treated as two different persons with separate
personalities distinct from each other. The owner is classified as a human person, while the business
is treated as a juridical person. (Juridical means that the business has a legal personality by itself. The
permit to operate given by the government makes the business the right to legally exist). This
concept is known as the business entity concept.
To Illustrate:

MARVIN REYES MR ENTERPRISES

(Owner) (owned by Marvin Reyes)

Human Person Juridical Person

Figure 1. Business Entity Concept (The owner and the business are two separate entities)

The personality of the owner is different from the personality of the business. Any private and
personal incomes and expenses of the owner/s should not be treated as the incomes and expenses
of the business. Accounting is concerned only with the transactions of the business and not those of
the owner/s.
Since the business is treated as a “person”, there should be a medium of communication for
the business and the owner or other interested parties to understand each other. This medium of
communication between the business entity and the owner or other users is known as accounting.
The final product of accounting process is called the financial statements. The business is “talking”
through the financial statements; hence, accounting is considered as “the language of business”.
NATURE OF ACCOUNTING
The basic features of accounting are as follows:
1. Accounting is a process. A process is composed of multiple steps that lead to a common
end goal. Accounting is a process because it performs the functions of identifying, recording,
and communicating economic events with the end goal of providing information to internal
and external parties.

2. Accounting is an art. Art refers to a way of performing something. Accounting is an art of

recording, classifying, summarizing, and finalizing financial data. Accounting is a
combination of techniques and its application requires applied skill and expertise.
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3. Accounting deals with financial information and transactions. Accounting deals only with
quantifiable financial transactions (transactions with money values). These are the only
events identified by the accountant, recorded in the books, and communicated to different
parties.

4. Accounting is a means and not an end. Accounting is a tool to achieve specific objectives.
It is not the objective itself. Imagine that you dream to go to Canada someday. Accounting
can be thought of as the plane that will bring you to your destination.

5. Accounting is an information system. Accounting is recognized and characterized as a

storehouse of information. As a service function, it collects processes and communicates
financial information to any entity. This discipline of knowledge has been evolved out to meet
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 the need of financial information required by different interested groups.
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FUNCTIONS OF ACCOUNTING
The definition of accounting enumerates the following basic functions:
1. Recording
2. Classifying
3. Summarizing
4. Interpreting

The four basic functions of accounting are broadly classified into: 1) mechanical phase and 2)
analytical phase. The mechanical phase of accounting includes recording, classifying, and
summarizing, while interpreting is considered as the analytical phase of accounting.
The functions of accounting are listed in the order of procedural process. This means that the first
step in accounting is recording, followed by classifying, then summarizing, and finally, interpreting
as illustrated in figure 2.

Recording Classifying Summarizing Interpreting

Mechanical Phase of Accounting Analytical Phase

Figure 2. Procedural Steps in Accounting

Recording
Recording refers to the routine and mechanical process of writing down business
transactions. Only business transactions and events that are quantifiable or measurable (in terms of
money) are recorded in the books of accounts in chronological manner. Recording is otherwise
known as journalizing or bookkeeping.
Usually, business transactions are recorded daily and chronologically. Chronological
recording of business transactions and events means that the order of writing is based on when the
events happened. In simple terms, the transaction that happens first shall be recorded first.
For example, the transactions that transpired on March 1 shall be recorded in the books of
the business ahead of those transactions that happened on March 2.
Business transactions are recorded in the books of accounts. There are two sets of books used
to record business transactions – the journal and the ledger.
The journal is considered as the book of original entry; hence, all business transactions are
recorded in the journal for the first time. The ledger, on the other hand, is called the book of final
entry. It is in the ledger where the transactions recorded in the journal are classified.

Classifying
Classifying refers to the process of sorting or grouping similar business transactions and events
into their respective kinds or classes. In other words, similar transactions and events should be
grouped together.
The grouping of similar transactions is recorded in the ledger. Hence, the information
recorded in the journal is transferred to the ledger. The process of transferring the same information
from the journal to the ledger is technically known as posting.
Posting of information is usually made at the end of the month. This process is shown in figure 3.

Posting

Journal Ledger
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 Figure 3. Relationship of Journal and Ledger

Summarizing
Summarizing is the phase in the accounting process which involves preparation of the
financial statements. The financial statements are the final product of accounting. It is through the
financial statements that accounting information is communicated to various interested users. The
financial statements reflect the operating performance and financial condition of the business. The
decisions of various users are highly dependent on the information provided by the financial
statements.
Ordinarily, the summarizing process starts from the preparation of the trial balance,
determination of adjusting entries, and the preparation of the worksheet. These steps will be
discussed lengthily in the succeeding chapters.
The complete set of financial statements includes the following:
1. Statement of financial position
2. Statement of comprehensive income
3. Statement of changes in equity
4. Statement of cash flows
5. Notes to the financial statements
The accounting process ends when the financial statements have been prepared and issued
to interested users.

Interpreting
The last function of accounting is interpreting. It is not a mechanical function, but rather an
analytical function. Interpreting refers to the process of analyzing and evaluating the information
presented in the face of financial statements and the accompanying notes.
The data found on the face of the financial statements and other related accounting
information are analyzed to determine the profitability of the business, its ability to pay its current
maturing obligations, and its ability to remain stable after paying long-term maturing financial
obligations.
The financial statements present the following information:
1. Profitability of the business
2. Liquidity of the business
3. Stability of the business
4. Management efficiency

Profitability refers to the ability of the business to realize more revenues than expenses. This
information is reflected in the income statement. Several ways may be adopted by the
management to improve profitability of the business.
Liquidity refers to the ability of the business to pay its current maturing obligations or those
obligations that are payable within one year. The business is considered liquid when it has more
resources to settle its financial obligations that are maturing within one year from the date of the
financial statements.
Stability refers to the ability of the business to pay its long-term financial obligations and remain
stable. Long-term obligations are those payables of the business that mature beyond one year from
the date of the financial statements.

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 Both the liquidity and stability status of the business are shown in the balance sheet. This implies
that users who give preference or importance to liquidity and stability should focus their analysis and
evaluation on the balance sheet.
Management efficiency reflects how effective and efficient the management is in utilizing its
resources. Resources like cash, products intended for sale, building, land, and other similar resources
are entrusted to the management. The resources are expected to grow through effective and
efficient management.

Accounting versus Bookkeeping

The term bookkeeping has a limited scope than accounting. Bookkeeping refers to the
recording aspect of the accounting process or cycle. Accounting, on the other hand, has a wider
scope and involves not only the recording aspect but also the preparation and interpretation of
financial statements.
Technically, bookkeeping is the chronological recording of the business transactions and
events in the book of accounts. It includes the preparation of trial balance. Accounting however,
connotes applications of proper accounting procedures and principles from the recording stage
up to the preparation of financial statements.
Bookkeeping is usually performed by a bookkeeper. He is responsible for keeping the
financial records of the business. The nature of his work is highly clerical and mechanical. On the
other hand, accounting is undertaken by an accountant. He reviews the work of the bookkeeper
although, in some instances, his works involves some level of bookkeeping. An accountant should
have a higher degree of knowledge and analytical skills. In big businesses, accountants are usually
Certified Public Accountants.

LESSON 2: USERS OF ACCOUNTING INFORMATION

Financial accounting information is used by a variety of groups and for diverse purposes. The
needs and expectations of users determine the type of information required. The following are the
users of financial information and their information:
1. Management. The financial accounting information guides the management in making
policies, planning for the future, and evaluating the financial status of the business.
2. Investors. Financial statements provide potential investors the necessary information to
decide if they will invest in the business or not.
3. Creditors/Lenders. Before creditors grant loans to a business, they first examine its financial
statements because they want to know whether the business applying for a loan has the
ability to pay including the interest when due date comes. Common examples of
creditors are banks, lending institutions and wealthy individuals.
4. Government/BIR. The government particularly looks at the income, revenues, and
expenses of a business to determine taxation policies, regulate the activities of the
enterprise, and as a basis for national income and statistics.
5. Employees. Employees are interested in information about the stability and profitability of
the enterprise. They are interested in information which enable them to assess the ability
of the enterprise to provide renumeration, retirement benefits, and employment
opportunities.

6. Customers. By analyzing the accounting information of a business, customers can

determine if it will be profitable for them to transact with the business. Also, customers
have an interest in information about the continuance of an enterprise especially when
they have a long-term involvement with or are dependent on the enterprise.
7. Academe. Member of the academe (e.g., professors, researchers, students) benefit from
the accounting information in the financial statements of a company. Although they do
not usually transact with businesses, members of the academe utilize financial statements
for academic purposes.

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 8. Public. Enterprises affect the members of the public in a variety of ways. For example,
enterprises make substantial contributions to the local economy in many ways including
the number of people they employ and their patronage of local suppliers. Financial
statements may assist the public by providing information about the trends and recent
developments in the prosperity of the enterprise and the range of its activities.

LESSON 3: FORMS OF BUSINESS ORGANIZATION

Businesses are organizations commonly made to earn profit. Throughout its life, a business
deals with multiple groups of individuals to achieve its end goal of profit generation.
There are four forms of business organizations available to aspiring businessmen:
1. Sole Proprietorship
2. Partnership
3. Corporation
4. Cooperative

Each form of business organization has its own advantages and disadvantages. Aspiring
businessmen take these into consideration before deciding what form of business they will take.

SOLE PROPRIETORSHIP
Sole proprietorships, as the name suggests, are businesses formed by a single individual. Sole
proprietorship is considered the simplest form under which a business can operate. Unlike
partnerships and corporations, businesses operating as sole proprietorships 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.
Even though sole proprietorships do not have separate legal existence, owners can choose
to operate the business under their own names or use fictitious name such as Aling Nene Sari-Sari
Store. Fictitious names are merely trade names that aim to instill brand recall to customers. Thus,
fictitious names do not, in any way, result in separate juridical personality for the business.

Advantages of a Sole Proprietorship

1. Ease of formation
Sole proprietorships are much easier to establish than other forms of business organizations. A
sole proprietorship 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. In addition, 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.
2. The owner has full control of the business
Being a sole proprietorship, 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 proprietor can easily make decisions to solve problems faced by the business. The
importance of fast decision-making is emphasized when problems warrant immediate action.
Furthermore, having only a single owner, a sole proprietorship does not experience internal conflict
regarding business decisions. Internal conflict can be harmful in business. In the worst scenario, it can
even be the cause of the downfall of the business.
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. Partnerships and corporations do not have
this advantage. If a business is experiencing financial difficulties, a sole proprietor may use personal

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assets to help the business recover. This is not the case for partnerships and corporations since
additional investments of owners in such corporations alter their profit-sharing structures.
4. Owners have all the profit 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. Obviously, sole proprietorships do not need to worry about such things.

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.

Disadvantages of a Sole Proprietorship

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.
2. Difficulty of raising additional capital
As mentioned, sole proprietorships are characterized by having only one owner. The initial
investment of the owner is the capital of the business. When all of the initial investments are 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.
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. Other forms of business organizations that have multiple owners do not usually
have this problem. Biases do not usually prevail in the other forms of business organizations since
there are many owners who decide.
Moreover, 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.

PARTNERSHIP
According to the partnership code of the Philippines, Title IX of the Civil Code of the
Philippines, 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.
From this definition of partnership given by the law, we can take note of the following things:
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.
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 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).

General Features of a Partnership

1. Separate legal existence

A partnership can also be defined as an artificial being created by operation of law. This
results in partnerships having juridical personalities separate and distinct from their owners (called
partners). Being an artificial person, a partnership can perform the acts that the partners can do
except those acts that purely personal in nature. Some examples of these acts are voting in elections
and holding positions in public office.
Unlike a sole proprietorship that transacts with other parties under the name of the owner, 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.
2. Mutual agency
Partners, being co-owners of the business, can perform acts for the partnership even without
asking permission from the 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. The following example will further illustrate this point.
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? 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.
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. In the ABC Partnership, if it has debt that is not paid by the partnership assets,
creditors can go after the personal assets of Andre, Bart, and Charles. Creditors can require a
particular partner to pay the whole amount of debt. If, for example, Andre paid the whole amount
of the partnership’s debt not paid by the partnership assets, Bart, and Charles are required to
reimburse him for their proportionate share in the debt.
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 occurs when there is a change in the relationship among the
partners. 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. During
liquidation, partnership assets are sold, liabilities are paid, and the remaining assets are distributed
to the partners. Liquidation ends the life of the partnership.
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 5. Co-ownership of partnership property
In the formation of partnership, partners contribute money, property, and industry into a
common fund. Once a partner has contributed his or her money and/ or property, it does not belong
to him or her anymore. The contributed money and property belong to the partnership and the
partners only have a proportionate share of partnership assets.
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.
6. Partnership agreement
The definition provided by the law states that partnership is a contract. Contracts are
perfected through oral or written agreement. Thus, a partnership can be formed orally or 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 articles of partnership, and it contains the following
information:
a. Name of the partnership
b. Location of the principal office of the partnership
c. The names, citizenship, and residence of the partners
d. Term for which the partnership is to exist

Advantages and Disadvantages of a General Partnership

Advantages Disadvantages

• Easier to create than a corporation

• Better ability to acquire additional capital than • Unlimited liability
sole proprietorships • Mutual agency
• Large pool of human capital than sole • Limited life
proprietorships

Other forms of Partnership

The partnership we have just discussed is called a general or regular partnership. Because of the
unlimited liability characteristic of a general partnership, individuals planning to work together
sometimes use the other forms of partnership. These are the Limited Partnership and Limited Liability
Partnership.

Limited Partnership
In a limited partnership, at least one partner has unlimited liability and at least one partner
has limited liability. Partners having unlimited liability are called general partners while partners
having limited liability are called limited partners. Limited partners are exposed to a lower level of
risk. The maximum loss that a limited partner can shoulder amounts to his or her initial investment.
Creditors cannot go after his or her personal assets.
To compensate general partners for the higher level of risk they take, they are the only ones
allowed to participate in the management of the partnership. If a limited partner participates in the
management of the partnership, he or she loses the limited liability protection. He or she becomes
a general partner.
Limited Liability Partnership

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 The limited liability partnership is a type of partnership that aims to protect innocent partners
from the malpractice and wrongdoings of the partners. This kind of partnership possesses multiple
insurance claims to protect the partners from such wrongful acts of other partners. The limited liability
partnership is mostly used by individuals forming a partnership for the practice of a profession (e.g.,
lawyers, accountants, medical professionals, auditors).

Advantages and Disadvantages of Different Forms of Partnership

Form of Partnership Advantages Disadvantages

• Owners (partners)
• Simple and inexpensive to
General Partnership personally liable for
create and operate
business debts.
• Limited partners have
limited personal liability for • General partners
business debts as long as personally liable for
they do not participate in business debts.
Limited Liability management. • More expensive to create
Partnership • General partners can raise than regular partnership.
cash without involving • Suitable mainly for
outside investors in companies that invest in
management of business. real state.

• Mostly of interest to • Unlike a limited liability

partners in old-line company, owners
professions such as law, (partners) remain
medicine, and personally liable for many
Limited Partnership accounting. types of obligations owed
• Owners (partners) are not to business creditors,
personally liable for the lenders, and landlords.
malpractice of other • Often limited to a short list
partners. of professions.

CORPORATION
Our law defines a corporation as “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.”
This definition emphasizes four things about a corporation.
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.

Unlike in the definition of a partnership, the law did not mention the purpose of a corporation.
Corporations can be organized to generate profit or it may be not-for-profit. This is one classification
of corporations. Corporations can also be classified as being publicly held or privately held. A
publicly held corporation has thousands of stockholders (owners) while a privately held corporation
has only a few.

General Features of a Corporation

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 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.

2. Limited liability
The limited liability characteristic is an advantage a corporation has over a partnership. The
personal assets of the stockholders of a corporation are protected from the claims of creditors and
other outside partners. Thus, the maximum loss that a stockholder can bear equals his or her
investment. This characteristic is a major consideration of aspiring businessmen who do not want to
be exposed to too much risk. Even if the corporation is bankrupt or has unpaid claims due to
accidents and lawsuits, the stockholders cannot be obligated to pay any deficiency.
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. This is not the case in a partnership. In a partnership, an individual cannot be admitted
as a partner without the consent of all existing partners. Stocks of a corporation can be transferred
even without the consent of other stockholders unless the corporation is privately held.
Transfers of stocks do not result in the dissolution or liquidation of a corporation. Stock transfers
are normal for corporations especially for those that are publicly held. This does not, in any way,
affect the operations of the corporations.
Moreover, a corporation may sell additional stocks to existing stockholders or to other persons
outside the company. This enables a corporation to acquire additional capital with relative ease.
4. Virtually unlimited life
A corporation shall exist for a period not exceeding 50 years from the date of its formation.
The term of a corporation may, however, be extended for periods not exceeding 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.
The withdrawal, death, and admission of stockholders only change the composition of the owners
of a corporation, but these events do not require the stockholders to formulate a new agreement.
A corporation does not need to deal with legal formalities associated with these events unlike a
partnership.
5. Corporation management
The management structure of a corporation is more complex than that of other forms of
business organizations. Stockholders are the owners of a corporation. However, unlike in sole
proprietorships and partnerships where the owners or partners manage the business, stockholders
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. Stockholders can also be a member of the board of directors.
The board delegates individuals to certain positions. The board selects the president or chief
executive officer and other vice-presidents. The following exhibit shows the management structure
of a corporation.

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 Management Structure of a Corporation

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. Large corporations provide employment
opportunities to the public and stimulate the growth of the company. The bankruptcy of a large
corporation can cause the whole economy to spiral downwards. Government regulations are
designed not only for the protection of public interest, but also for stockholders’ as well.
7. Double Taxation
The income of a corporation is taxed on the corporate level and the individual level. The
income of a sole proprietorship or a partnership is part of the individual income of the owners. It is
taxed once the owners file their respective tax returns. 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.

8. Dividends
When a sole proprietorship or partnership generates income, it is immediately distributed to
the owners or partners. This is not the case for a corporation. 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
approved the distribution. The income distributed to stockholders is called dividends.
Dividends may be in the form of cash, stock, or property. Cash dividends are distribution of
income in the form of cash. It is normally stated as a nominal amount of per share of stock. For
example, if the board of directors declared cash dividends of ₱2 per share of stock, an individual
holding 1000 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 1000 shares of stock will receive 1000 units of inventory.

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 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.

Advantages and Disadvantages of a Corporation

Advantages Disadvantages

• Ability to acquire additional capital • Heavily regulated by the government

• Transferable ownership rights • Double taxation
• Limited liability of stockholders • Not easy to form
• Virtually unlimited life • More expensive to form than sole
• Large pool of human capital proprietorships and partnerships

COOPERATIVES
According to the Cooperative Code of the Philippines, “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.”
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.
According to the same Code, the primary objective of a cooperative is to provide goods
and services to its members and enable them to attain increased income and savings. 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.

Other characteristics of a cooperative include the following:

1. It can be sued and be sued under its own name.
2. It has the right of succession.
3. Members of a cooperative are subject to limited liability.
4. 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.
5. A cooperative has its set of board of directors.
6. Income of a cooperative (called net surplus) belongs to its members.

Comparing the Forms of Business Organization

Sole
Item Partnership Corporations Cooperatives
Proprietorship
1. Number of 2 or more 5 or more
1 15 or more
Possible Owners (usually 2-5) (usually 5-15)

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 Board of Board of Directors
2. Management Owner (but he Partners (or
Directors and and operating
(who manages may hire they may hire
operating management
the business) somebody) managers)
management
As stated in the
As stated in the
Death of any Articles of
Articles of
3. Termination of Death of the partner or Cooperation, not
Incorporation,
the Business owner withdrawal of to exceed 50
not to exceed 50
a partner years.
years.
In limited
4. Government capacity, DTI SEC CDA
agency assigned (DTI - In limited (Securities & (Cooperative
primarily to Department of capacity, DTI Exchange Development
regulate Trade & Commission) Authority)
Industry)
Sell the
business or
Sell the business
interest of a Cannot transfer
5. Transfer of (it’s a new
partner Sell stocks nor sell his
Ownership entity under a
(consent of membership
new owner)
other partners
is necessary)

Generally
unlimited; the
other
properties of
the partners
Unlimited; other
may be held
properties not
liable for the
used in the Limited to the Limited to the
obligations of
6. Liability of business may stock investment capital
the
Owners be held liable of the contribution of
partnership.
for the shareholder the member
obligations of
There are
the business
types of
partnerships
that limit the
liability of the
partners.

LESSON 4: TYPES OF BUSINESS ACCORDING TO ACTIVITIES

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 as follows:
1. Service Business
2. Merchandising Business
3. Manufacturing Business

Service Business
This type of business offers professional skills, advice and consultations. The primary source of
revenues of service business is the performance of services, often referred to as service revenues. A
law firm is an example of a service business as it provides legal advice to its clients. Other examples
are barber shops, beauty parlors, laundry shops, repair shops, accounting firms and tutorial centers.
Merchandising Business

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 Unlike service business, this type of business sells tangible products. This type of business buys
finished or almost finished goods from their suppliers and resells the same to their customers at prices
higher than their purchase costs. Merchandising business is also known as “buy and sell”.
Merchandising companies primarily earn revenues from the sale of the goods or merchandise, also
known as sales revenue or sales. There are two types of merchandising businesses – retailers and
wholesalers. A merchandising business that sells goods directly to customers is called a retailer, while
a wholesaler is a merchandising business that sells goods to retailers.
The operating cycle of a merchandising business is typically longer than that of a service
business. 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.
As an example, National Book Store buys school supplies from various suppliers such as Pilot,
Cattleya, Crayola, and 3M. These school suppliers 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 store.

Cash on
hand

Receives
payment Buys
from goods
customers

Stores
Sells
goods as
inventory
inventory

Operating Cycle of Merchandising Business

Manufacturing Business
This type of business buys raw materials and uses them in making a new product.
Manufacturing Companies, or simply manufacturers, are relatively complicated organizations than
service and merchandising companies. 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. 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.
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
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 customers. Likewise, the operating cycle of a manufacturing company ends with the collection of
cash payments.
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 of 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.

Operating Cycle of Manufacturing Business

Comparing the Types of Business

Type of
Business Advantage Disadvanta
Definition Input Output Examples
According s ges
to Activities

16
 Businesses
Absence Inability to
that
of Standardize Accounting
generally
Inventory services and law firms,
use their Intangible;
Service Labor hospitals,
employees Service
No Maintaining schools,
to provide
Production human salons, shops
services to
facilities capital
customers

Businesses
that buy
Visible
finished or Supermarkets,
Goods or Products
almost convenience
merchand Tangible;
Merchandisi finished Managing stores, book
ise bought Merchandi Less
ng goods from inventory stores,
from se conversion,
their department
suppliers time, and
suppliers and stores
effort
resell the
same to
customers
Quality Generally, Car
Manufacturi Businesses Raw Tangible; Control Needs companies,
ng that create materials, Manufactu Production consumer
their own labor, red Visible Facilities products
products overhead products products companies,
High electronics
Conversion companies,
Costs energy
manufacturers
Cost of
Quality
Control

Managing
inventory

LESSON 5: BASIC ACCOUNTING CONCEPTS AND PRINCIPLES

Accounting concepts, principles, and assumptions are essential in the practice of

accountancy. Financial statements become more comparable and more useful to users if these
concepts, principles, and assumptions are followed by businesses. They serve as the foundation of
accounting in order to avoid misunderstanding and enhance the understanding and usefulness of
the financial statements.
1. Business entity principle – means the business is considered as an entity that is separate and
distinct from the owner of the business.

Example: If Mr. Cruz has a barbershop business, the cash of the barbershop should be
reported separately from the personal cash of Mr. Cruz.

2. Going concern principle – means the business is expected to remain in operation indefinitely.

Example: When preparing financial statements, you should assume that the business will
continue its operation indefinitely.

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 Generally, no business is operated to exist just for a certain period of time. It is always assumed
that the business will operate indefinitely, as long as it is able.

3. Objectivity principle – This objectivity principle requires a transaction to have a basis that can
be verified. Some form of objective evidence or documentation must exist to support a
transaction before it can be entered into the accounting records. Examples of evidences are
invoices, receipts or contracts.

Example: When a customer paid Jollibee for his order, Jollibee should have a copy of the
receipt to present as evidence of the sale that took place.

4. Monetary unit principle – means all transactions of the business are recorded using the
national monetary unit. In the Philippines the national monetary unit is pesos. Therefore, the
amounts in every transaction must be stated in pesos.

Example: Jollibee should report financial statements in pesos even if they have stores in the
United States.

5. Cost principle – means assets should be shown on the balance sheet at the cost of the
purchase not of the current value.

Example: When the business purchased a laptop, it should be recorded at the price it was
purchased.

6. Materiality principle – means that in case of assets that are immaterial to make a difference
in the financial statement, the business should instead record it as an expense.

Example: The business purchased an eraser for its office use and it has an estimated useful
life of two years. Since the eraser is immaterial relative to assets, it should be
recorded as an expense.

7. Conservatism principle – also known as prudence, means that in case of doubt, assets and
income should not be overstated while liabilities and expenses should not be understated.

Example: In case of doubt, expenses should be recorded at a higher amount and revenue
should be recorded at a lower amount.

8. Accrual accounting principle – means 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. The essence of
accrual accounting is, it does not have to wait for the cash to be received or for cash to be
paid before the business transaction will be recorded.

Example: Mr. Jose, a barber, performed his service to a customer on credit. Mr. Jose should
record the amount for the service he rendered even if his services has not been
paid yet.

9. Matching principle – The matching principle reinforces the accrual basis of accounting.
Under this principle, assets are consumed to generate sales revenue inflows while outflows of
assets are identified as operating expenses. The matching principle requires that for each
accounting period all sales revenues earned must be recognized, whether payment is
received or not. It also requires the recognition of all operating expenses incurred, whether
paid or not during the period. The revenues of the business always come with expenses; they
always go together. In other words, if the revenues are recorded in period 1, the related
expenses should also be recorded on period 1.

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 Example: When the business bought equipment and there is a transportation cost incurred
related to the purchase, the transportation cost should be recorded as an expense
for that period.

REFERENCES:

Aduana, Nick L. (2016). Fundamentals of Accountancy, Business, and Management 1. EDSA,

Quezon City. C & E Publishing, Inc.
Florendo, Joselito G. (First Edition). Fundamentals of Accountancy, Business, and Management 1.
Manila, Philippines. REX Book Store
Lopez, Rafael Jr. M. (2016 Edition). Fundamentals of Accounting (Simplified Procedural Approach).
Davao City, Philippines: MS LOPEZ Printing & Publishing

Prepared by: Prof. WENIFREDA C. LUMOGDANG

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