IAAP-1ST

Definition of Accounting

Accounting is "the process of identifying measuring and communicating economic information to permit informed judgments and decisions by users of the information." - (American Association of Accountants)

Three important activities included in the definition of accounting

1. Identifying

2. Measuring

3. Communicating

Identifying

Identifying is the process of analyzing events and transactions to determine whether or not they will be recognized.

Recognition refers to the process of including the effects of an accountable event in the statement of financial position or the statement of comprehensive income through a journal entry.

Only accountable, events are recognized (ie., journalized).

An accountable event is one that affects the asset, liabilities, equity, income or expenses of an entity. It is also known as economic activity, which is the subject matter of accounting. Only economic activities are emphasized and recognized in accounting.

Sociological and psychological matters are not recognized.

Non-accountable events are not recognized but disclosed only in the notes, if they have accounting relevance: Disclosure only in the notes is not an application of the recognition process. A non-accountable event that has an accounting relevance may be recorded through a memorandum entry.

Types of events or transactions

1. External events - are events that involve an entity and another external party.

Types of External events

i. Exchange (reciprocal transfer) - an event wherein there is a reciprocal giving and receiving of economic resources or discharging of economic obligations between an entity and an external party.

Examples: sale, purchase, payment of liabilities, receipt of notes receivable in exchange for accounts receivable, and the like.

i. Non-reciprocal transfer - is a "one way" transaction in that the party giving something does not receive anything in. return, while the party receiving does not give anything in exchange.

Examples: donations, gifts or charitable contributions, payment of taxes, imposition of fines, theft, provision of capital by owners!, distributions to owners 1, and the like.

1 FASB Accounting Standards Codification (ASC) 845

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iii. External event other than transfer - an event that involves

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changes in the economic resources or obligations of an entity caused by an external party or external source but does not involve transfers of resources or obligations. Examples: changes in fair values and price levels, obsolescence, technological changes, vandalism, and the

2.

like.

Internal events - are events that do not involve an external party.

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Types of Internal events i.

Production

- the process by which resources

are

transformed into finished goods. Examples: conversion of raw materials into finished products, production of farm products, and the like.

ii. Casualty - an unanticipated loss from disasters or other similar events. Examples: loss from fire, flood, and other catastrophes.

Measuring

Measuring involves assigning numbers, normally in monetary terms, to the economic transactions and events.

Several measurement bases are used in accounting which include, but not limited to, historical cost, fair value, present value, realizable value, current cost, replacement cost and sometimes inflation-adjusted costs. The most commonly used is historical cost. This is usually combined with the other measurement bases. Accordingly, financial statements are said to be prepared using a mixture of costs and values. Costs include historical cost and current cost while values include the other measurement bases.

Valuation by fact or opinion

The use of estimates is essential in providing relevant information.

Thus, financial statements are said to be a mixture of fact and opinion.

When measurement is affected by estimates, the items

measured are said to be valued by opinion. Examples:

a. Estimates of uncollectible amounts of receivables. b. Depreciation and amortization expenses, which are affected by estimates of useful life and residual value.

C.

Estimated liabilities, such as provisions.

d. Retained earnings, which is affected by various estimates of income and expenses

When measurement is unaffected by estimates, the items®

measured are said to be valued by fact. Examples:

a. Ordinary share capital valued at par value

b. Land stated at acquisition cost

c. Cash measured at face amount

Communicating

Communicating is the process of transforming economic data into useful accounting information, such as financial statements and other accounting reports, for dissemination to users. It also involves interpreting the significance of the processed information.

The communicating process of accounting involves three aspects:

1. Recording - refers to the process of systematically committing into writing the identified and measured accountable events in the journal through journal entries.

2. Classifying - involves the grouping of similar and interrelated items into their respective classes through postings in the ledger.

3. Summarizing - putting together or expressing in condensed form the recorded and classified transactions and events. This includes the preparation of financial statements and other accounting reports.

Interpreting the processed information involves the computation of financial statement ratios. Some regulatory bodies, such as the Bangko Sentral ng Pilipinas (BSP), require certain financial ratios to be disclosed in the notes to financial statements. Basic purpose of accounting

The basic purpose of accounting is to provide information that is useful in making economic decisions.

Various sources of information are used when making economic decisions and the financial statements are only one of those sources. Other sources may include current events, industry

publications,

internet resources, professional advices, expert

systems, etc.

Economic entities use accounting to record economic activities, process data, and disseminate information intended to be useful in making economic decisions.

An economic entity is a separately identifiable combination of persons and property that uses or controls economic resources to achieve certain goals or objectives. An economic entity may either be a:

a. Not-for-profit entity - one that carries out some socially desirable needs of the community or its members and whose activities are not directed towards making profit; or

b. Business entity - one that operates primarily for profit.

Economic activities are activities that affect the economic resources (assets) and obligations (liabilities), and consequently, the equity of an economic entity. Economic activities include:

1. Production - the process of converting economic resources into outputs of goods and services that are intended to have greater utility than the required inputs.

2. Exchange - the process of trading resources or obligations for other resources or obligations.

3. Consumption - the process of using the final output of the production process.

4. Income distribution - the process of allocating rights to the use of output among individuals and groups in society.

5. Savings - the process of setting aside rights to present consumption in exchange for rights to future consumption.

6. Investment - the process of using current inputs to increase the stock of resources available for output as opposed to immediately consumable output. Types of information provided by accounting

1. Quantitative information - information expressed in numbers, quantities, or units.

2: Qualitative information - information expressed in words or descriptive form. Qualitative information is found in the notes to financial statements as well as on the face of the other financial statements.

Financial information - information expressed in money.

Financial information is also quantitative information because monetary amounts are normally expressed in numbers.

Types of accounting information classified as to users' needs

1. General purpose accounting information - designed to meet the common needs of most statement users. This information is provided under financial accounting. General purpose information is governed by generally accepted accounting principles (GAAP) represented by the Philippine Financial Reporting Standards (PFRSs).

2. Special purpose accounting information - designed to meet the specific needs of particular statement users. This information is provided by other types of accounting other than financial accounting, e.g., managerial accounting, tax basis accounting.

Sources of information in financial statements

Information in the financial statements is not obtained exclusively from the entity's accounting records. Some are obtained from external sources. For example, fair value measurements, resolutions of uncertainties, future lease payments, and contractual commitments are only a few of the information presented in the financial statements that are derived from external sources.

Accounting as science and art

1. As a social science, accounting is a body of knowledge which has been systematically gathered, classified and organized. Overview of Accounting

7

As a practical art, accounting requires the use of creative skills and judgment.

Accounting as an information system

Accounting identifies and measures economic activities, processes information into financial reports, and communicates reports to decision makers.

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Accounting as a language of business

Accounting is often referred to as a "language of business" because it is fundamental to the communication of financial information.

Creative and Critical thinking in accounting

The practice of accountancy requires the exercise of creative and critical thinking. a.

Creative thinking involves the use of imagination and insight to solve problems by finding new. relationships (ideas) among items of information. It is most important in identifying alternative solutions.

Critical thinking involves the logical analysis of issues, using inductive or deductive reasoning to test new relationships to determine their effectiveness. It is most important in evaluating alternative solutions.

Creative skills and juagment are exercised in problen:

solving. The following are the steps in problem solving:

1. Recognizing a problem

2. Identifying alternative solutions

3. Evaluating the alternatives

4. Selecting a solution from among the alternatives

5. Implementing the solution

Accounting Concepts

Accounting concepts refer to the principles upon which the process of accounting is based. The term "accounting concepts" is used interchangeably with the following terms: • Accounting assumptions (Accounting postulates) - are the fundamental concepts or principles and basic notions that provide the foundation of the accounting process.

•

Accounting theory - is logical reasoning in the form of a set of broad principles that (i) provide a general frame of reference by which accounting practice can be evaluated and (ii) guide the development of new practices and procedures. It is the organized set of concepts and related principles that explain and guide the accountant's action in identifying, measuring communicating accounting information. Accounting theory comprises the Conceptual Framework and the Philippine Stancral Reporting Standards, particularly the PERS Accounting Standards.

Most accounting concepts are derived from the Conceptual Framework and the PFRS Accounting Standards. However, some accounting concepts are implicit, meaning they are not expressly stated in the Framework or PFRS but are generally accepted because of their long-time use in the profession.