Financial Accounting And Reporting PDF

FINANCIAL ACCOUNTING AND REPORTING (FUNDAMENTALS) Accounting as Science and Art Definition of Accounting 1. As a social science, accounting is a body o...

FINANCIAL ACCOUNTING AND REPORTING (FUNDAMENTALS) Accounting as Science and Art Definition of Accounting 1. As a social science, accounting is a body of knowledge which has been systematically gathered, classified and organized. Accounting is a process of identifying, recording and communicating economic information that is 2. As a practical art, accounting requires the use of creative skills and judgement. useful in making economic decisions. Accounting as an Information System Essential elements of the definition of accounting A system is one that consists of an input, a process, and an output. For example, in your digestive 1) Identifying – the accountant analyzes each business transaction and identifies whether the system, the input is the food you eat; the process is when your body produces digestive juices to convert transaction is an “accountable event” or “non-accountable events”. This is because only the food into an output called? ……………energy! (The output my friend is energy. The one you are “accountable events” are recorded in the books of accounts. “Non-accountable events” are thinking of is called waste.) your body needs energy so it can function properly. not recorded in the books of accounts. “Accountable events” (economic events) are those that affect the assets, liabilities, Similarly, in an accounting system, the inputs are the identified accountable events; the equity, income or expenses of a business. Sociological and physiological matters processes are recording, classifying and summarizing; and the output is the accounting report that is are outside the scope of accounting. communicated to the users. 2) Recording – the accountant recognizes (i.e., records) the identifies “accountable events”. Bookkeeping and Accounting This process is called “journalizing”. Although bookkeeping function is part of accounting, bookkeeping and accounting are not the same. After journalizing, the accountant then classifies the effects of the event on the “accounts.” This process is called “posting.”  Bookkeeping refers to the process of recording the accounts or transactions of an entity.  Account is the basic storage of information in c\accounting, e.g., “cash,” “land,” “sales,” etc. Bookkeeping normally ends with the preparation of the trial balance. Unlike accounting, bookkeeping does not require the interpretation of the significance of the information 3) Communicating – at the end of each accounting period, the accountant summarizes the processed. information processed in the accounting system in order to produce meaningful reports. This  Accounting, covers the whole process of identifying, recording, and communicating is important because information processed in the accounting system, is useless unless it is information to interested users. communicated to interested users. Accounting information is communicated to interested users through accounting reports, the most common form of which is the financial Functions of Accounting in Business statements. Accounting is often referred to as the “language of business” because it is fundamental to the Nature of Accounting communication of financial information. Accounting is a process with the basic purpose of providing information about economic activities Accounting has the following two broad functions in a business: that is intended to be useful in making economic decisions. 1. To provide external users with information that is useful in making, among others, Types of Information Provided by Accounting investment and credit decisions; and 2. To provide internal users with information that is useful in managing the business. 1. Quantitative information: information expressed in numbers, quantities, or units. 2. Qualitative information: information expressed in words or descriptive form. Qualitative Users of Accounting Information: Users of accounting information are broadly classifies into two, information is found in the notes to financial statements as well as on the face of the other namely: components of financial statements. 1. Internal Users – those who are directly in managing the business. Examples of internal users 3. Financial information: information expressed in money. Financial information is also include: quantitative information because monetary accounts are normally expressed in numbers. a) Business owners who are directly involved in managing the business. b) Board of Directors c) Managerial personnel  2. External Users – those who are not directly involved in managing the business. Examples Examples in Which Accounting is Used in Investment and Credit Decisions. of external users include; a) Existing and potential investors (e.g., stockholders who are not directly involved External use of information Decision Accounting Decision in managing the business) 1) Investor  Shall I invest in this  The financial business? Is this a performance of the b) Lenders (e.g., banks) and Creditors (e.g., suppliers) profitable undertaking? business. c) Government agencies (e.g., Bureau of Internal Revenue ‘BIR’, Securities and 2) Creditor  Shall I lend money to  The ability of the Exchange Commission ‘SEC’) this business? Does this business to generate d) Non-managerial employees business have the revenue and cash flows e) Customers ability to pay back my from its operations. f) Public loan? Users of Accounting Information Brief History of Accounting Only the internal users are directly involved in managing the business. Accounting can be traced as far back the prehistoric times. Since the dawn of civilization when mankind Types of Accounting Information Classified as to Users’ Needs began to engage in trade, perhaps more than 10,000 years ago, methods of record keeping and accounting have been invented. 1) General Purpose accounting information – is information designed to meet the common needs of most statement users. It is provided by financial accounting and is prepared As early as 8500 B.B., accounting has already existed. Archaeologists have found clay token primarily for external users. as old as 8500 B.C., in Mesopotamia which were usually cones, disks, spheres and pellets. These tokens 2) Special Purpose accounting information – is information designed to meet the specific needs correspond to commodities like sheep, clothing or bread. They were used in the Middle West in keeping of particular statement users. It is provided by management accounting or other branches of tablets. During such time, the tokens were replaced by wet clay records. During such time, experts concluded this to be the start of the art writing. accounting and is prepared primarily for internal users. Other ancient civilizations keeping account records are Babylonia (4500 B.C.), Egypt (2250 Examples of Decisions and Types of Information Needed to Make Those Decisions B.C.), China and Greece. User Example of decision to make Example of Information Needed In the Middle Ages (13th and 15th centuries), trade flourished in places such as Florence,  Existing Investor:  Audited financial Venice, and Genoa. This has brought advancement in account keeping methods, in 1211 A.D., one of 1) External user (Investor) Whether to hold or sell statements of the the systems in accounting was kept by a Florentine banker. However, the system was primitive as the investment in stocks. business to aid in concept of equality for entries was absent. Double entry records first came out during 1340 A.D. in  Potential Investor: analyzing of value of Genoa. Whether or not to buy the company. (General shares of stocks. purpose information) In 1494, the first systematic record keeping dealing with the “double entry recording 2) External User (Lender or  Lender: Whether or not  Audited financial system” was formulated by Fra Luca Pacioli, a Franciscan monk and mathematician. The “double Supplier) to extend loan to a statements of the entry recording system” was included in Pacioli’s book titled “Summa di Arithmetica Geometria business. business to aid in Proportioni and Proportionista”, published on November 10, 1494 in Venice.  Supplier: Whether or analyzing the The concept of “double entry recording” is being used to this day. Thus, Fra Luca Pacioli is not to extend credit to a company’s ability to considered as the father of modern accounting. business. pay its debts. (General purpose information) Common Branches of Accounting 3) Internal User (Manager)  Whether or not to  Analysis of the effects increase the sale price of sales volume and 1) Financial accounting: focuses on general purpose Financial Statements. of a product. sales prices to earnings. (Special purpose  Governed by PFRS information)  General Purpose Financial Statements – cater to the common needs of external users, primarily the potential and existing investors, lenders and other creditors. 4) Internal User (Manager)  How much capital is  Budget report. (Special needed to manufacture purpose information) a new product? Financial Accounting Vs. Financial Reporting – both focus on general purpose financial statements. 7) Accounting Education: refers to the teaching accounting and accounting-related subjects in an However, financial reporting endeavors to promote principles that are useful to “other financial organized learning environment. It is a process of facilitating the acquisition of knowledge and skills reporting”. regarding one or more of the other branches of accounting. “Other financial reporting” – comprises information provided outside the financial statements that 8) Accounting Research: pertains to the careful analysis of economic events and other variables to assists in the interpretation of a complete set of financial statement. understand their impact on decisions. Accounting research includes a broad range of topics, which may be related to one or more of the other branches of accounting, the economy as a whole, or the market Financial Statements – structured representation of an entity’s financial position and results of its environment. Examples are provided below: operations. It is the end product of the accounting process. Accounting Research Topic Related branch of Accounting Financial Report – included the financial statements plus other information provided outside the  Impact of fair value measurement on the  Financial Accounting financial statements. financial statements.  Inventory management and its effect on  Management Accounting Financial Statements Financial Report earnings. 1) Statement of financial position 1) Statement of financial position  Internal controls and modern technology.  Auditing 2) Statement of profit or loss and other 2) Statement of profit/loss and other  Becoming a certified public accountant.  Accounting Education comprehensive income comprehensive income 3) Statement of changes in equity 3) Statement of changes in equity 4) Statement of cash flows 4) Statement of cash flows 5) Notes 5) Notes SUMMARY: 6) Additional statement of financial position 6) Additional statement of financial position Branch of Accounting Type of Accounting Service Users of Service 7) Other information Provided Primary Objective of FR: provide information about an entity’s economic resources (assets). Claims 1) Financial Accounting  General record-  All business use to those resources (Liabilities and Equity), and changes in those resources (income, expenses, and other keeping, i.e., financial accounting in changes). maintenance of their record-keeping. Journals and Ledgers. These records provide Second Objective of FR: provide information useful in assessing the entity’s management information that is also stewardship. used in the other branches of accounting. 2) Management Accounting: Involve in the accumulation and communication of information for use  Businesses prepare by internal users. An offshoot of management accounting is management advisory services.  Preparation of general- general purpose FS at purpose financial least annually for the Financial Accounting Management Accounting statements (FS). use of lenders, Focuses on the information needs of Focuses on the information needs of investors, or external users. internal users. government regulatory bodies. 3) Government Accounting: accounting for the government and its instrumentalities, focusing 2) Management  Preparation of  Required by attention on the custody of public funds, purpose to which those funds are committed, and the Accounting specifically tailored management to aid responsibility and accountability of the individuals entrusted with those funds. management reports. them in performing their management 4) Auditing: involves the inspection of an entity’s financial statements to ascertain their functions. correspondence with an established criteria. 3) Government  General record-keeping  Required by the Accounting and preparation of government and its 5) Tax Auditing: preparation of tax returns and rendering of tax advice. financial reports for the agencies. government and its 6) Cost Accounting: the systematic recording and analysis of the costs of materials, labor, and overhead agencies. It also incident to the production of goods or rendering of services. includes the preparation of budgets  and accountability 8) Accounting Research  Accounting research  Required by business reports. papers, articles and owners, professional 4) Auditing  Expression of an  Businesses with gross similar publications. organizations, and opinion on the annual sales or receipts other interested parties. correspondence exceeding P3,000,00 between management are required to have assertions and their financial SUMMARY: Forms of Business Organization established criteria. statement audited by an independent Certified Form of business organization Ownership Formation/Registration Public Accountant 1. Sole Proprietor  One individual (i.e.,  Registered with the (CPA). sole proprietor) DTI  The most common 2. Partnership  More than one (i.e.,  Formed by contractual forms of an audit partners) agreement. opinion is the  Registered with the Independent Auditors’ SEC. Report which is 3. Corporation  More than one (i.e.,  Formed by operation of attached to audited stockholders) law. financial statements.  Registered with the 5) Tax Accounting  Preparation of tax  All businesses are SEC. returns. required to file tax 4. Cooperative  More than one (i.e.,  Formed inn accordance *Failure to file tax returns results returns. members) with the Cooperative to penalty and imprisonment of not Code. less than 6 years but not more than  Registered with the 10 years. CDA.  Providing tax advice.  Some taxpayers may Advantages and Disadvantages of the Different Forms of Business Organization require the professional advice of a tax Sole Proprietorship practitioner regarding the management of Advantages Disadvantages taxes.  You are the boss and you keep all the  You assume all the risk of loss. 6) Cost Accounting  Analyses of costs of  Businesses use cost profits. products or services. accounting to analyze  Decision making is simple because you  You take all responsibility and rely mostly the cost of their have complete control over the business. on yourself in making decisions. products or services  Relatively easier and less costly to form  It is more difficult to raise capital because and the effects of those because there are fewer formal business you rely mostly on your personal assets costs in, among others, requirements. and loans to initially finance the business. earnings and pricing  Lower extent of government regulation  You are personally liable for the debts and policies. and relatively lower taxes. obligations of the business. 7) Accounting Education  Teaching of accounting  Required by business and related subjects. students, business owners, accounting Partnership professionals in their Continuing Advantages Disadvantages Professional  Better business decisions can be made  Making business decisions may give rise to Development (CPD), because “two heads are better than one”. conflict among the partners. and other interested parties.   You share the business risk and the  You don’t keep all the profits because you Cooperative responsibility of running the business with need to share them with your partner(s). your partner(s). Advantages Disadvantages  Compared to corporations and  Limited life, in the sense that a partnership  Unlike in a corporation, your “say” on  A cooperative is prone to poor cooperatives, a partnership is easier to can be easily dissolved by the withdrawal, cooperative affairs is not affected by the management. Cooperatives are, more often form because only a contractual agreement retirement, death or insanity of one of the number of share you own. This is because, than not, managed by members who were between the partners is needed. partners. in a cooperative, each member is entitled to elected as board of directors rather than by  Greater capital compared to a sole  Lesser capital compared to a corporation. only one vote regardless of his or her employed professional managers. Since proprietorship. shareholdings. However, members with there is a ‘one—member, one-vote’ policy  Relatively lower extent of government  A partnership (other than a general larger shareholdings are entitled to larger on a cooperative, influential members tend regulation compared to corporations. professional partnership) is taxed like a share in profit (net surplus). to dominate the election process. The result corporation. is that those who get elected may not be the  Unlimited liability. The partners can be ones who are most qualified for the task. held liable for partnership debts up to their  A cooperative is generally exempt from  A cooperative is susceptible to corruption. personal assets. paying taxes. This is the main advantage of Due to its management structure and lack a cooperative and the most common reason of profit motive, the elected officers may why cooperatives are organized. be inclined to act on their personal Moreover, a cooperative may receive interests. Corporation assistance from the government. Advantages Disadvantages  Compared to a corporation, a cooperative  The Cooperative Code places some  A stockholder who is not a member of the  Your “say” on corporate affairs depends on is easier and less costly to form because restrictions on the distribution of a corporation’s board of directors is relieved the number of shares you own. Those who there are fewer formal business cooperative’s profit to its members. More from managerial responsibilities. Only the own more shares are the bosses and enjoy requirements. specifically the Code requires a stockholders that are elected as members of a larger share of the corporation’s profits. cooperative to appropriate a portion of its the board of directors and those they hire annual profit to some funds. Only the or appoint are tasked with managerial remaining can be distributed to the responsibilities. This can be an advantage members. because a regular investor does not need to work for the corporation to earn income. Furthermore, when the cooperative is dissolved, the  Limited liability of the owners because  A corporation is more difficult and more amount accumulated in a fund called “reserve fund” stockholders are liable for corporate debts costly to form because there are more will not be returned to the members, but rather donated only up to the amount they have invested. formal business requirements. to another cooperative or to the community.  Greater capital and ease in raising  Greater extent of government regulation  Limited liability – the members are liable  Compared to a corporation, it is more additional funds because a corporation can and higher taxes. for cooperative debts only up to the amount difficult for a cooperative to sustain issue shares to a wider extent of investors. they have invested. growth. This is in part because of the lack  If the corporation is listed, you can easily  Unlike for a sole proprietorship or a of profit motive and the lack of transfer your shares to other investors by partnership where business profits are management expertise. Moreover, a selling them in the stock market. Many easily distributed to the owner(s), in a cooperative’s success strongly depends on investors earn profit this way – by buying corporation, you have to wait for the board the members’ cooperation and members shares at a cheap price, wit for prices to go of directors to declare dividends before you are not always willing to cooperate. The up, and then sell them. This activity is can get your share in the profits. success of a business depends on referred to as stock trading. continuing effort. Sadly, many  Unlimited life, in the sense that the cooperatives are zealous at the start but fail withdrawal, retirement, death or insanity of to sustain continuing effort resulting to the one of the stockholders does not dissolve warning down of their activities. This does the corporation. not mean though that all cooperatives are although a corporation has a legal life of 50 years, this small businesses. There are many multi- can be renewed for an indefinite number of renewals. billionaire cooperatives in our country. Some might be located in your community.   Unlimited life, in the sense that the  Unlike in a corporation where the withdrawal, retirement, death or insanity of stockholder can freely transfer his shares, one of the members does not dissolve the in a cooperative, there are restrictions on cooperative. the transfer of a member’s shares. For example, the approval of the board of Although a cooperative has a legal life of 50 years, this directors must first be obtained before a can be renewed for an indefinite number of renewals. member can transfer his or her shares. Types of Business According to Activities 1) Service Business – one that offers services as its main product rather than physical goods. It may offer professional skills, expertise, advice, lending service, and similar services. (i.e., Schools, Professionals (accounting firm, law firm, electrician), Hospitals and Clinics, Banks and other financial institutions, Hotels and restaurants, Transportation and travel (taxi operator, travel agency). Entertainment and event planners (wedding planners, concert promoters). 2) Merchandising Business (Trading Business) – one that buys and sells goods without changing their physical form. (i.e., General Merchandise resellers (grocery stores, department stores, hardware stores, pharmacies, online stores, sari-sari stores) and Distributors and Dealers (rice wholesalers, vegetable dealers, 2nd hand car dealers.) 3) Manufacturing Business - one that buys raw materials and processes them into final products. It changes the physical form of the goods it has purchased in a production process. For example. A business that buys and sells eggs is a merchandising business. On the other hand, a business that buys eggs and uses the eggs as ingredient in making cakes for sale is a manufacturing business. (i.e., Car Manufacturers (Toyota, Isuzu, Volkswagen, etc.), Technology Companies (Apple, Samsung, Sony), Food processing companies (San Miguel Pure Foods, Silver Swan), Factories (clothing factories, animal feeds factories, plastic wares factories). Some business, called Hybrid Business, engage in more than one type of activity. For example, a restaurant uses ingredients to cook a meal (manufacturing), sells Coca-Cola drinks (merchandising), and serves food to customers (service).