Accounting: Identifying, Measuring, Communicating

Overview of Accounting

• Accounting is identifying, measuring, and communicating economic information for informed judgments and decisions
• Key activities: identifying, measuring, and communicating

Identifying

• Analyzing events to determine recognition
• Recognition includes effects in financial position or comprehensive income via journal entry
• Only accountable events are recognized (journalized)
• An accountable event affects assets, liabilities, equity, income, or expenses, also known as economic activity
• Sociological and psychological matters are not recognized
• Non-accountable events are not recognized but disclosed in notes if relevant

Types of Events

• External events involve an entity and another external party
• Exchange (reciprocal transfer) involves reciprocal giving and receiving of economic resources
• Sale, purchase, payment of liabilities, and receipt of notes receivable are examples of exchange
• Non-reciprocal transfer is a "one-way" transaction
• Donations, gifts, taxes, fines, theft, and distributions to owners are examples of non-reciprocal transfer
• External events other than transfer involve changes to economic resources or obligations due to an external party, but not transfers of resources

Internal Events

• Internal events are events that do not involve an external party
• Production transforms resources into finished goods
• Casualty is an unanticipated loss from disasters

Measuring

• Assigning numbers, usually in monetary terms, to transactions and events
• Measurement bases include historical cost, fair value, present value, realizable value, current cost, replacement cost, and inflation-adjusted costs
• Historical cost is most commonly used and is often combined with other measurement bases
• Financial statements use a mixture of costs and values

Valuation

• The use of estimates is essential in valuation, thus financial statements are a mixture of fact and opinion
• Measurement that’s affected by estimates is said to be valued by opinion
• Examples of item valued by opinion: uncollectible receivables, depreciation expenses affected by estimates of useful life and residual value, estimated liabilities, and retained earnings
• When unaffected by estimates, measurement is valued by fact
• Examples of item valued by fact: ordinary shares at par value, land stated at acquisition cost, and cash measured at face value

Communicating

• Transforming economic data into useful accounting information, such as financial statements, for dissemination to users
• It involves interpreting the significance of the processed information
• The communicating process involves recording, classifying, and summarizing

Accounting Purpose

• 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 financial statements are only one of many
• Economic entities use accounting to record economic activities, process data, and disseminate information intended to be useful in making economic decisions.

Economic Entity

• A separately identifiable combination of persons and property that uses or controls economic resources to achieve certain goals or objectives
• May be a:
• Not-for-profit entity is an one that carries out socially desirable needs without the goal of profit
• Business entity operates primarily for profit
• Economic activities affect economic resources (assets), obligations (liabilities), and equity
• Economic activities include:
• Production - converting economic resources into goods and services with greater utility than the required inputs
• Exchange is process of trading resources or obligations for other resources or obligations
• Consumption - using the final output of the production process
• Income distribution - allocating rights to the use of output among individuals and groups in society.
• Savings - setting aside rights to present consumption in exchange for rights to future consumption
• Investment - using current inputs to increase stock of resources available for output

Types of Information

• Quantitative information is expressed in numbers, quantities, or units
• Qualitative information is expressed in words or descriptive form
• Financial information is expressed in money
• General purpose accounting information - designed to meet the common needs of most statement users; provided under financial accounting and governed by GAAP (Philippine Financial Reporting Standards)
• Special purpose accounting information - designed to meet the specific needs of particular statement users; provided by other accounting types than financial accounting (e.g., managerial accounting, tax basis accounting)
• For the sources of information in financial statements, not all info comes from entity accounting records, some are derived from external sources e.g. fair value measurements, resolutions of uncertainties, future lease payments and contractual commitments.

Accounting Foundations

• As a social science, accounting systematically gathers, classifies, and organizes knowledge
• As an art, accounting requires creative skills and judgment
• Accounting identifies and measures economic activities, processes information into financial reports, and communicates these reports to decision makers
• Accounting is referred to as the "language of business"

Creative and Critical Thinking

• The practice of accountancy requires the exercise of creative and critical thinking
• Creative thinking involves the use of imagination and insight to solve problems by finding new relationships (ideas). 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 effectiveness. it is most important in evaluating alternative solutions
• Steps: recognizing a problem, identifying alternative solutions, evaluating the alternatives, selecting a solution from among the alternatives, and implementing the solution

Accounting Concepts

• Refers to the principles upon which the process of accounting is based
• Accounting assumptions (postulates) are fundamental concepts, principles, and basic notions that provide the foundation of the accounting process
• Accounting theory is logical reasoning that provides a frame of reference for practice evaluation and guides the development of new practices and procedures
• Accounting theory includes the Conceptual Framework and the Philippine Financial Reporting Standards (PFRSs)
• Most accounting concepts are derived from the Conceptual Framework and the PFRSs
• Some concepts are implicit and have been accepted due to long-time use
• Double-entry system records each accountable event in two parts - debit and credit
• Going concern assumption assumes the entity will continue operations for an indefinite period and measurement basis is involving mixture of costs and values is appropriate only when the entity is a going concern
• Separate entity concept views the entity separately from its owners, so personal transactions are not recorded in the entity's accounting records and accordingly, the personal transactions of the owners among themselves or with other entities are not recorded in the entity’s accounting records
• Stable monetary unit assumption states assets, liabilities, equity, income, and expenses are stated in terms of a common unit of measure and that the purchasing power of the peso is regarded as stable or constant and that its instability is insignificant and therefore ignored so accounting information should be stated in a common denominator
• Time Period (Periodicity/ Accounting period) divides the life of the entity into series of reporting periods can be a calendar year or a fiscal-year period
• Materiality concept states that information is material if its omission or misstatement could influence economic decisions and that is a matter of professional judgment
• Cost-benefit (Cost constraint/ Reasonable assurance) states that the cost of processing and communicating information should not exceed the benefits to be derived from it.

Accounting Practices

• Accrual Basis of accounting states that the effects of transactions are recognized when they occur, not when cash is received or paid
• Under accrual basis, income is recognized when earned rather than when cash is collected and expenses are recognized when incurred rather than when cash is paid
• Historical cost concept (Cost principle) value of an asset is determined at acquisition cost but this concept is not always maintained
• Concept of Articulation states all of the components of a complete set of financial statements are interrelated and the financial statements are fundamentally interrelated and interact with each other
• Full disclosure principle recognizes that the nature and amount of information included in financial statements reflect a series of judgmental trade-offs which strive for sufficient detail to make a difference to users and sufficient condensation to make the information understandable, keeping in mind the costs of preparing and using it
• Consistency concept states that financial statements are prepared consistently from one period to the next and changes in accounting policies are disclosed in the notes
• Matching (Association of cause and effect) matches costs are expenses with the related revenue which is called a matching concept
• Entity theory accounting objective is geared towards proper income determination which emphasizes the income statement

Accounting theories

• Proprietary theory accounting objective is geared towards the proper valuation of assets and this theory emphasizes the importance of the balance sheet
• Residual equity theory this theory is applicable when there are two classes of shares issued, i.e., ordinary and preferred and applies in the computation of book value per share and return on equity
• Fund theory accounting objective is neither proper income determination nor proper valuation of assets but the custody and administration of funds and the objective is directed towards cash flows. This concept is used in government accounting and fiduciary accounting
• Realization is the process of converting non-cash assets into cash or claims for cash and it deals with revenue recognition
• Prudence (Conservatism) is the use of caution when making estimates under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated.
• Exercise of prudence doesn't allow deliberate understatement of assets or overstatement of liabilities to create hidden reserves
• Expense recognition principles include: Matching concept (Direct association of costs and revenues) - costs that are directly related to the earning of revenue are recognized as expenses in the same period the related revenue is recognized
• Systematic and rational allocation - costs that are not directly related to the earning of revenue are initially recognized as assets and recognized as expenses over the periods their economic benefits are consumed, using some method of allocation.
• Immediate recognition - costs that do not meet the definition of an asset, or ceases to meet the definition of an asset, are expensed immediately.

Branches of Accounting

• Financial accounting focuses on general purpose financial statements, which cater to the common needs of external users and it is governed by Philippines Financial Reporting Standards
• Management accounting provides information for internal users or management
• Cost accounting systematically records and analyzes the costs of materials, labor, and overhead incident to production
• Auditing evaluates the correspondence of certain assertions with established criteria, tax accounting prepares tax returns and renders tax advice, such as the determination of the tax consequences of certain proposed business endeavors, and government accounting accounts for the government and its instrumentalities.
• Fiduciary accounting handles accounts managed by a person managing property for the benefit of another and estate accounting handles accounts for fiduciaries who wind up the affairs of a deceased person.
• Social accounting communicates social and environmental effects of an entity's economic actions

Other Accounting Types

• Institutional accounting is for non-profit entities other than government
• Accounting system is installation of accounting procedures for data accumulation
• Accounting research carefully analyzes events to understand their impact on decisions

Other accounting info

• Bookkeeping records accounts/transactions but doesn't require interpreting the significance of processed information
• Accountancy is the profession/practice of accounting which can be public (rendering services to more than one client) or private not involving an employer-employee relationship

Sectors In the Practice of Accountancy

• Practice of Public Accountancy involves rendering audit or accounting related services to more than one client on a fee basis.
• Practice in Commerce and Industry work requires professional knowledge in accounting
• Practice in Education/Academe includes teaching of accounting.
• Practice in the Government employment or appointment to a position in an accounting professional group
• Accountants practicing in commerce and industry, education/academe and the government are considered in private practice

Accounting Standards

• Philippine Financial Reporting Standards (PFRSs) represent the generally accepted accounting principles (GAAP) in the Philippines which are Standards and Interpretations adopted by the Financial Reporting Standards Council (FRSC)
• PFRSs guidance assists entities in applying requirements some have mandatory guidances
• The need for reporting standards is for financial statements to be useful, which should be prepared using reporting standards as a way to heightened risk of fraudulent reporting
• In selecting accounting policies, entities consider existing PFRS, or management’s judgment in developing and applying an accounting policy that results in information that is relevant and reliable

Organization Structure

• Financial Reporting Standards Council (FRSC) is the official accounting standard setting body in the Philippines composed of fifteen (15) members
• Philippine Interpretations Committee (PIC) reviews interpretations of the International Financial Reporting Interpretations Committee (IFRIC) for approval and adoption
• Board of Accountancy (BOA) supervises the registration, licensure and practice of accountancy in the Philippines
• Securities and Exchange Commission (SEC) regulates corporations and the investing public
• Bureau of Internal Revenue (BIR) administers provisions of the National Internal Revenue Code
• Bangko Sentral ng Pilipinas (BSP) influences selections by banks
• Cooperative Development Authority (CDA) influences the selection and application of accounting policies by cooperatives

Accounting Guidelines

• International Accounting Standards Board (IASB) is the standard-setting body of the IFRS Foundation, created to develop and promote global accounting standards
• Standards issued by the IASB are called the International Financial Reporting Standards (IFRSs)
• IFRSs are developed through an international due process, which involves various steps
• International Financial Reporting Interpretations Committee (IFRIC) prepares interpretations of how specific issues should be accounted for under IFRS application and includes preparers and users
• IFRS Advisory Council (previously Standards Advisory Council 'SAC') groups organizations interested in reporting and advise on IASB priorities
• International Federation of Accountants (IFAC) develops the worldwide financial profession; membership is open to all legally recognized accountancy bodies
• International Organization of Securities Commissions (IOSCO) is an international body of security commissions

IFRS Transition

• Accounting standards used in the Philippines were based on US GAAP prior to the full adoption in 2005
• The move to IFRSs was mainly caused by the increased acceptance of IFRSs worldwide and the increasing internationalization of businesses, necessitating shared standards that reduce inconsistencies
• The goal is one set of global standards which reached a milestone in October 2002 by creating the Norwalk Agreement.
• Established financial reporting standards are continually reviewed, revised or superseded primarily to users’ needs
• New laws, politics, business/social environments, and regulation influence the choice of accounting treatment under standards