Fundamentals of Accounting: Systems, Functions, and Principles

Definitions and Fundamental Systems of Accounting

• Conceptual Overview

  • Accounting is characterized as a system that assists a business in tracking events.
  • It is defined as a process, implying a step-by-step procedure involving several stages: identifying events, recording, classifying, summarizing, reporting, and analyzing.

• Formal Definitions

  • Merriam-Webster: Defines accounting as the system of recording and summarizing business and financial transactions and analyzing, verifying, and reporting the results.
  • American Accounting Association (AAA): Defines it as the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by the users of information.
  • American Institute of Certified Public Accountants (AICPA): Defines it 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 character and interpreting the results thereof.

• Core Accounting Actions

  • Recording: The act of setting down in writing accountable transactions and events.
  • Classifying: The process of categorizing similar terms into the same group or group name.
  • Summarizing: The process of aggregating and creating a condensed version of the recorded and classified information.
  • Interpreting: The explanation, provided in understandable terms, of the data that has been recorded, classified, and summarized.

Functions of the Accounting Process

• Identifying Economic Events

  • This involves recognizing events relevant to the business, such as the transfer of things that have value.
  • Examples include buying equipment (on credit or debit), exchange of cash or equipment, and payment of suppliers.
  • Every identification must have proof of transactions, such as a payslip, receipt, or acknowledgment.

• Recording

  • This function involves writing down the identified economic events.
  • It serves as a comprehensive history of all financial activity.
  • Methodology: Performed in a systematic and chronological order.
  • Purpose: Allows for backtracking in case problems arise; typically performed by an accountant or bookkeeper.

• Classifying

  • This involves sorting or grouping similar transactions and events within a specific period of time.

• Summarizing

  • This step involves grouping various accounts from the classification process.
  • Accounts are grouped into categories: assets, liabilities, owner's equity, revenue, cost, and expenses.
  • Information is taken from the general ledger to create accounting reports.
  • Records are summarized on different schedules, such as annually or semi-annually.

• Reporting

  • This entails the preparation of financial statements to provide meaningful and presentable information.
  • Key financial statements include:
    • Statement of Financial Position
    • Statement of Comprehensive Income
    • Statement of Owner's Equity
    • Statement of Cash Flows
  • All transactions during the period are added and presented as a single whole amount.

• Interpreting

  • This is the final function in the process.
  • Data from financial reports is used as a basis for future planning and the framing of business policies.
  • It serves as the critical time for decision-making.

Nature and Characteristics of Accounting

• A Service Activity: Accounting provides professional services, particularly the preparation of financial reports, and is considered a specialized field.
• A Process: It consists of multiple steps (identifying, recording, summarizing, reporting) leading to the goal of providing information to internal and external parties.
• An Art: It is a way of performing tasks that entails creativity and skills; it is a combination of techniques and applications requiring expertise.
• Deals with Financial Information and Transactions: Accounting focuses on quantifiable financial transactions with numerical value. Non-financial transactions are not the primary focus, though non-financial data may assist in interpreting financial estimates.
• An Information System: Accounting acts as a storehouse of information. It allows for backtracking data (e.g., from $5$ years ago, depending on company policy) through the collection, processing, and communication of financial info.
• A Means and Not an End: It is a tool used to achieve specific objectives rather than being the objective itself.

Historical Roots and Legal Framework in the Philippines

• Luca Bartolomeo de Pacioli

  • Known as the Father of Modern Accounting.
  • Developed the double-entry bookkeeping system.
  • System includes a debit and credit for each transaction.
  • Transcript definition: DEBIT to take away money from the account; CREDIT to add money to the account.

• Accounting Standards

  • Harmonized through guidelines: Philippine Financial Reporting Standard (PFRS) and Philippine Accounting Standards (PAS).

• Philippine Accountancy Law

  • Current law: Philippine Accountancy Act of $2004$.
  • Specific legislation: R.A No. $9298$ (Republic Act No. $9298$).

Users of Accounting Information: External and Internal

• External Users (Secondary Users)

  • Individuals and organizations outside the company not directly involved in management.
  • Customers: Acquire goods/services for a fee; main income source; assess supplier financial stability for long-term supply; check quality and warranty/after-sales obligations.
  • Creditors: Source of additional funds (banks, lending institutions, wealthy individuals, government); lend resources for a fee (usually interest); examine financial statements before granting loans.
  • Potential Investors: Provide additional fuel for the company; put resources in for a return; analyze financial ratios and feasibility.
  • Government: Regulates the economy and taxing authorities (BIR, SEC, DOLE, GSIS, SSS); checks compliance with law; scans revenues and expenses for tax purposes.
  • Academe: Professors, researchers, and students; use statements for academic blueprints, identifying industry trends, and improving standards.
  • Public: Uses info to understand economic conditions; determines if it is wise to start a business or look for a higher-paying job; helps in resource allocation.

• Internal Users (Primary Users)

  • Individuals inside the company who plan and run the business.
  • Management: Includes Board of Directors, top management, middle-level managers, and supervisors. They need info on income, sales, cash availability, and production costs to take measures to improve results (e.g., pricing or dividend decisions).
  • Employees: Not part of management; care about job security, salaries, and benefits (bonuses, insurance); use profit info to decide whether to stay or seek new employment.
  • Owners / Stockholders: Existing investors. They need info on profits, assets, and liabilities to decide on expansion, additional investment, or borrowing funds.

Types of Business Organizations

• Sole Proprietorship

  • Owned by a single individual; business is under one name.
  • Owner has unlimited liabilities, meaning personal assets may be used for business obligations.

• Partnership

  • Composed of two or more individuals.
  • At least one partner must have unlimited liability; others may have limited liability.

• Corporation

  • Can have many owners (up to $100$ or more).
  • Starts with at least $5$ owners known as incorporators (originals). Stockholders are those who joined later.
  • Managed by a Board of Directors elected based on stocks.
  • Article of Incorporation: Defines the termination of the business (generally not exceeding $50$ years, but can be updated).
  • Regulated by the SEC (Securities and Exchange Commission).
  • Personal assets are generally protected; stocks can be sold to exit.

• Cooperatives

  • Requires a minimum of $15$ members to start.
  • Primary goal is to help the members.
  • Regulated by the CDA (Cooperative Development Authority).
  • Members elect the operating management; shares/interests are transferable but generally cannot be sold in the same way as corporate stocks.

Business Classifications by Activity

1. Service Business: Offers professional skills, advice, and consultation.
2. Merchandising Business: Buys goods at wholesale and sells them at retail (e.g., cellphones). Profit is made by selling at a price higher than the purchase cost.
3. Manufacturing Business: Buys raw materials and combines them with labor and expenses to create new products for sale (e.g., a bake shop).

Specialized Branches of Accounting

• Financial Accounting: Focuses on general-purpose reports, recording transactions, and financial statements.
• Auditing: Independent examination of financial statements by a CPA to express an opinion on the fairness of presentation. It checks compliance with standards using a step-by-step procedure.
• Management Accounting: Accumulation and communication of information for internal management use, including business policies, product costs, and distribution.
• Government Accounting: Accounting for the national government and instrumentalities, focusing on the custody and commitment of public funds.
• Tax Accounting: Preparation of tax returns and advice on the tax consequences of proposed business endeavors (often involving the BIR).
• Fiduciary Accounting: Handling accounts managed by a person entrusted with property for the benefit of another.
• Social Responsibility Accounting: Reporting on programs and projects related to the welfare of the community or nation (often involving the DSWD).
• Environmental Accounting: Focuses on projects centered on care for the environment. An example is the ‘Cap and Trade Scheme’ involved in carbon accounting to reduce greenhouse gas emissions.
• Price-Level Accounting: Also known as Accounting for Hyperinflationary Economies (see PAS $29$). It recognizes changes in the purchasing power of money rather than assuming a stable monetary unit.
• Accounting Education: Practiced by CPAs who are professors, tasked with preparing entrants into the profession.

Areas of Professional Practice

• Public Accounting: Individual practitioners or firms rendering expert services (Audit/Assurance, Taxation, Management Services) to the public for a fee.
• Private Accounting: Accountants employed in business enterprises on a salary basis to assist management in planning and controlling operations.
• Government Accounting: Accountants employed in government branches such as the BIR, COA (Commission on Audit), and SEC.
• Accounting Education: Teaching accounting and related subjects.

Accounting Concepts and Principles

1. Business Entity Principle: The business enterprise is separate and distinct from its owner or investor.
2. Going Concern Principle: The business is expected to continue its operations indefinitely.
3. Time Period Principle: Financial statements are divided into specific time intervals.
4. Monetary Unit Principle: Financial amounts are stated in a single monetary unit.
5. Objectivity Principle: Financial statements must be presented with supporting evidence.
6. Cost Principle: Accounts should be recorded initially at their original cost.
7. Accrual Accounting Principle: Revenue is recognized when earned (regardless of collection) and expenses are recognized when incurred (regardless of payment). This contrasts with the Cash Basis Principle, which is not generally accepted today.
8. Matching Principle: Costs should be matched with the specific revenue they helped generate.
9. Disclosure Principle: All relevant and material information must be reported.
10. Conservatism Principle: Also known as Prudence. In cases of doubt, assets and income should not be overstated, while liabilities and expenses should not be understated.
11. Materiality Principle: If an asset is too immaterial to change the meaning of the financial statements, the company may record it immediately as an expense.

Notable Quotes on Professionalism

• “Preparation is the best way to develop confidence. There is no better way in any battle than being prepared.” — Atty. Janet Abuel, CPA ($1\text{st}$ place, $1998$ Bar Exam).
• “Success seems to be connected with action. Successful people keep moving. They make mistakes, but they don’t quit.” — Conrad Hilton.
• “Basic Concept in all CPA Board Exam Subjects is the Foundation.” — Darell Asuncion, CPA.