Accounting Overview Chapter 1

Chapter 1: Overview of Accounting

• Accounting is the process of identifying, measuring, and communicating economic information to support informed decisions by users.
• Three key activities in accounting are:
  • Identifying: Determining events and transactions that are relevant and need to be recognized. Only accountable events are considered.
  • Measuring: Assigning numerical values, usually monetary, to economic events and transactions.
  • Communicating: Transforming economic data into useful accounting information like financial statements for users.

The Basic Accounting Equation

• Assets = Liabilities + Stockholders' Equity
  • Assets: Economic resources owned by a business.
  • Liabilities: Financial obligations or debts of the business.
  • Stockholders' Equity: Owners' claims on the assets of the business.

Types of Events

• External Events: Involve an external party.

  • Exchange Events: Reciprocal giving and receiving.
  • Non-reciprocal Transfer: One-way transaction.
  • Other External Events: Changes in resources or obligations caused by an external party, without resource transfer.

• Internal Events: Do not involve an external party.

  • Production: Transforming resources into finished goods.
  • Casualty: Unanticipated loss from disasters or similar events.

Measurement

• Several ways to measure, including but not limited to:
  • Historical cost
  • Fair value
  • Present value
  • Current cost
  • Inflation-adjusted costs
• Historical cost is the most common method.

Users of Accounting Information

• External Users:

  • Lenders
  • Investors
  • Consumer Groups
  • External Auditors
  • Governments
  • Customers

• Internal Users:

  • Managers
  • Officers
  • Sales Staff
  • Employees
  • Internal Auditors
  • Owners

• General Purpose Accounting Information: Meets the common needs of various users, governed by Philippine Financial Reporting Standards (PFRSs).

• Special Purpose Accounting Information: Meant to meet the needs of specific users. Examples include managerial, tax-basis, and others.

Concepts in Accounting

• Double-Entry System: Each accountable event is recorded in two parts (debit and credit).
• Going Concern: Businesses are assumed to operate indefinitely.
• Separate Entity: The business is treated independently from its owners.
• Stable Monetary Unit: Financial statements use a common unit of measure (e.g., peso), ignoring changes in purchasing power.
• Time Period: Business life is divided into reporting periods.
• Materiality: An event is material if its omission or misstatement could influence economic decisions.
• Cost-Benefit: The cost of processing and communicating information should not exceed its benefits.
• Accrual Basis: Accounting recognizes the effect of transactions when they occur, rather than when cash is exchanged.
• Historical Cost: The value of an asset is determined by its acquisition cost.
• Articulation: Components of financial statements are interrelated.
• Full Disclosure: Financial statements provide sufficient detail for users while remaining understandable.
• Consistency: Accounting policies and methods are applied consistently.
• Matching: Costs are recognized as expenses when the related revenue is recognized..
• Residual Equity Theory: Used when there are multiple stock classes (ordinary and preferred).
• Fund Theory: Focuses on the custody and administration of funds.
• Realization: The process of converting non-cash assets to cash.
• Prudence/Conservatism: Includes a degree of caution when making estimates in uncertain situations.
• Common Branches of Accounting:
  • Cost accounting
  • Financial accounting
  • Management accounting
  • Auditing
  • Tax accounting
  • Government accounting
  • Social accounting
  • Inflation accounting

Other Accounting Concepts

• Four sectors/practices in accountancy: public accountancy, commerce/industry, academe, and government.

• Conceptual Framework for Financial Reporting: Provides the underlying concepts for financial statement preparation. The objective is to provide information useful to investors, lenders and creditors in making decisions regarding resources provided to the entity. A secondary objective is to show results of the stewardship of management.

• Qualitative Characteristics: Relevance (predictive value and feedback value, especially materiality), and faithful representation (completeness, neutrality, free from error). Other enhancing characteristics: comparability, verifiability, timeliness, and understandability.

• Elements of Financial Statements:

  • Financial Position:
    • Assets: Economic resources with future benefits.
    • Liabilities: Obligations to transfer resources.
    • Equity: Assets minus Liabilities
  • Performance:
    • Income: Revenues generated and gains realized.
    • Expenses: Costs and losses incurred

• PAS 1: Presentation of Financial Statements Sets the basis for presenting a general-purpose financial statement, with a goal to improve comparability between and within entities.

• Complete Set of Financial Statements: Includes statement of profit or loss and comprehensive income, statements of changes in equity, statement of cash flows, notes, and disclosures.

• General Features: including Fair Presentation and Compliance with PFRS, Going Concern, Accrual Basis of Accounting, Materiality, and Aggregation.

• Various accounting methods like the nature of expense method, and presentation of deferred tax.

• PAS 2 Inventories: Inventories are measured at the lower of cost and net realizable value. Cost formulas include specific identification, FIFO, and weighted average. Inventories are presented as a line item on the statement of financial position.

• Classification of Assets and Liabilities: Current assets are expected to be realized or used up in one operating cycle, while non-current assets are not. The same is true for liabilities.