Financial Accounting and Reporting PDF

FINANCIAL ACCOUNTING AND REPORTING CHAPTER 1: Introduction to Accounting DISCUSSION OVERVIEW: I. Definition of Accounting II. Steps of Accounting Process III. Objectives of...

FINANCIAL ACCOUNTING AND REPORTING CHAPTER 1: Introduction to Accounting DISCUSSION OVERVIEW: I. Definition of Accounting II. Steps of Accounting Process III. Objectives of Accounting IV. Users of Accounting Information V. Branches of Accounting VI. Fundamental Business Model VII. Types of Business According to Activity VIII. Forms of Business Organizations IX. Activities In Business Organization VI. FUNDAMENTAL BUSINESS MODEL For a business to be successful, it needs to develop a product or service that customers will pay for and thus create a revenue stream. It can be a new product or service that meets specific needs. It can also be a better product or service. Or, it can a product or service that offers a better value proposition. A business requires investments to enable it to pay for the infrastructure, equipment and personnel. Only after a skillful combination of these elements can a business generate a revenue stream. Figure 1-1 illustrates how a business is structured to provide a customer proposition. The business model is built on five activities: 1. First, the investors provide the required capital for the business. The cash investment will then be held in a bank account. 2. The cash in the business can be:  Converted into another type of asset that will be used in the business (e.g. equipment) or sold (e.g. inventory); or  Spent on operating costs such as salaries, rentals and utilities. 3. The combination of business resources provides the basis for producing the products or services. 4. The sale of a product or service generates an asset called a receivable. This asset once collected will produce a cash inflow for the business. 5. If there's an existing debt from banks, the cash inflow from collections will be used to provide the debt providers with interest on their loans to the company. The rest of the cash can be sent back to the cycle by being converted into other assets or spent on operating costs (back to stage 2). In the normal course of business, this whole process will earn profits on which tax will have to be paid. Any profit after tax can continue to be reinvested in the cycle or paid out to the owners as a "return" on their investments. The model illustrates the way money flows around a business and provides the basis of accounting. To manage a business effectively it is important to know how the cash has been spent and how profitable the products or services have been to the business. The availability of this historic information helps management to make judgments on how to improve the performance of business. Financial Accounting and Reporting (FAR) BCC-FAR | A.Y. 2024 - 2025 Prof. Kenneth B. Pedrajas, CPA, CTT  VII. TYPES OF BUSINESS ACCORDING TO ACTIVITY 1. SERVICE BUSINESS - Firms that generally use their employees to provide intangible products or services to customers. 2. MERCHANDISING / TRADING- Firms that buys finished or almost finished goods from their suppliers and resells the same to customers. 3. MANUFACTURING - Firms that create or manufacture their own products / goods. Financial Accounting and Reporting (FAR) BCC-FAR | A.Y. 2024 - 2025 Prof. Kenneth B. Pedrajas, CPA, CTT  TYPES OF BUSINESS ACCORDING TO ACTIVITY Although the fundamental business model does not vary, there are infinite ways of applying it to provide the range of products and services that make up the business world. However, the range of products and services can be summarized in seven broad categories, they are as follows: Financial Accounting and Reporting (FAR) BCC-FAR | A.Y. 2024 - 2025 Prof. Kenneth B. Pedrajas, CPA, CTT  K- tanungan: 1. The sale of a product or service generates an asset called a _____________. 2. ______ ____ is a requirement from a business owner in order to conduct his/her business and is also the starting point of the Fundamental Business Model. 3. Which of the following is not the second step in the Fundamental Business Model? a. Loan the business’ cash on hand/ cash in bank in the employee. b. Used the cash on hand/ cash in bank to purchase new building c. Paid the employee for their salary and training costs. d. Acquisition of a new delivery vehicle for the transfer of products to customer. 4. Which of the following is NOT an example of a business entity that offers raw material as their main course of the business? a. Farming b. Electricity c. Mining d. Oil industry 5. The following are branch of accounting, among the choices, which is widely used by a Manufacturing Company? a. Management Accounting b. Internal Auditing c. Financial Accounting d. Cost Accounting 6. _________ & _______ are example of a Merchandising Business. 7. What is the third step in the normal operating cycle of the Manufacturing Business? 8. MimA OtLuM Company offers a salon business to its customer for a haggard free life with a slogan, “Would you mind? Paganda na!”. Which of the following statement is not correct? a. MimA OtLuM company is a service business. b. MimA OtLuM company ‘s input of her business is the labor of her employees. c. MimA OtLuM company’s output is tangible service. d. MimA OtLuM company perform services to its customer. Financial Accounting and Reporting (FAR) BCC-FAR | A.Y. 2024 - 2025 Prof. Kenneth B. Pedrajas, CPA, CTT  VIII. FORMS OF BUSINESS ORGANIZATIONS DEFINITION OF TERMS: Organization - a collection of people working together to achieve a common purpose. Business Organization - a collection of people working together to achieve a common purpose in relation to their organization's mission, vision, goals, and objectives, sharing a common organizational culture. TYPES OF BUSINESS ORGANIZATIONS I. Single/Sole Proprietorship II. Partnership III. Corporation I. SINGLE/SOLE PROPRIETORSHIP - A form of business that is owned, managed and controlled by an individual. It is the simplest and the most numerous form of business organization. This business organization has a single owner called the proprietor who generally is also the manager. Sole proprietorships tend to be small service-type (e.g. physicians, lawyers and accountants) businesses and retail establishments. The owner receives all profits, absorbs all losses and is solely responsible for all debts of the business. From the accounting viewpoint, the sole proprietorship is distinct from its proprietor. Thus, the accounting records of the sole proprietorship do not include the proprietor's personal financial records. Advantages Disadvantages  Ease of Formation  Unlimited liability  Owner has full control of the business  The owner can freely mix personal assets with business assets  Difficulty of raising additional capital  Owner has all the profits for himself or herself  Simple Taxation  Owner's bias. II. PARTNERSHIP - A partnership is a business owned and operated by two or more persons who bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing the profits among themselves. Each partner is personally liable for any debt incurred by the partnership. Accounting considers the partnership as a separate organization, distinct from the personal affairs of each partner. Different Types of Partners: General partners - Who invest in the partnership, participate in the day-to-day operations and are liable for debts and lawsuits of the partnership. Limited partners - Who invest in the partnership but who have no participation in day-to-day operations and who are not usually considered to have liability is distinct from its proprietor. Thus, the accounting records of the sole proprietorship do not include the proprietor's personal financial records. Different Types of Partnership:  General Partnership - An association of two or more persons that carry on as the co-owners of a business in order to generate a profit. The default rule is equality between all members and the only way to change this is through a formal written agreement. Each partner possesses an equal voice in management and the authority to act as agent for the partnership. Each partner can be held liable for all debts of the partnership, and for torts committed by other partners within the course of the partnership's business. Financial Accounting and Reporting (FAR) BCC-FAR | A.Y. 2024 - 2025 Prof. Kenneth B. Pedrajas, CPA, CTT   Limited Partnership – A limited partnership is formed by two or more persons, having one or more general partners and one or more limited partners. A limited partner has no voice in the active management of the limited partnership, which is conducted by the general partner(s). Every limited partner's liability is limited to the capital he has contributed to the partnership. Advantages Disadvantages  Easier to create than corporation  Unlimited liability  Better ability to acquire additional capital than sole  Mutual agency proprietorships  Limited life  Larger pool of human capital than sole proprietorship. III. CORPORATION - A corporation is a business owned by its stockholders. It is an artificial being created by operation of law, having the rights of succession and the powers, attributes and properties expressly authorized by law or incident to its existence. - Sec.2 of B.P. Blg. 68 (Corporation Code of the Philippines). The stockholders are not personally liable for the corporation's debts. The corporation is a separate legal entity. Advantages Disadvantages  Heavily regulated by the government  Ability to acquire additional capital  Double taxation  Transferable ownership rights  Not easy to form  Limited liability of stockholders  More expensive to form than sole  Virtually unlimited life proprietorship and partnership.  Large pool of human capital IX. ACTIVITIES IN BUSINESS ORGANIZATIONS Many types of decisions are made in business organizations. Accounting provides important information to make these decisions. The three types of organizational activities are as follows: financing, investing, and operating. I. Financing Activities Organizations require financial resources to obtain other resources used to produce goods and services. They compete for these resources in financial markets. Financing activities are the methods an organization uses to obtain financial resources from financial markets and how it manages these resources. Primary sources of financing for most businesses are owners and creditors, such as banks and suppliers. Repaying the creditors and paying a return to the owners are also financing activities. II. Investing Activities Managers use capital from financing activities to acquire other resources used in the transformation process-that is, to transform resources from one form to a different form, which is more valuable, to meet the needs of the people. Having the right mix of resources is essential to efficient and effective operations. An efficient business is one that provides goods and services at low costs relative to their selling prices. An effective business is one that is successful in providing goods and services demanded by the customers. Investing activities involve the selection and management including disposal and replacement of long-term resources that will be used to develop, produce, and sell goods and services. Investing activities include buying land, equipment, buildings and other resources that are needed in the operation of the business, and selling these resources when they are no longer needed. III. Operating Activities Operating activities involve the use of resources to design, produce, distribute, and market goods and services. Operating activities include research and development, design and engineering, purchasing, human resources, production, distribution, marketing and selling, and servicing. Organizations compete in supplier and labor markets for resources used in these activities. Also, they compete in product markets to sell the goods and services created by operating activities. Financial Accounting and Reporting (FAR) BCC-FAR | A.Y. 2024 - 2025 Prof. Kenneth B. Pedrajas, CPA, CTT  PACIOLI'S DOUBLE-ENTRY BOOKKEEPING In Fra Luca Pacioli's book, Summa, there are 36 short chapters on bookkeeping. Luca states that to be successful every merchant needs three essential things: sufficient cash or credit, a good bookkeeper, and an accounting system to view the business affairs at a glance. He discusses three books in the Summa: the memorandum, the journal and the ledger. Summa de Arithmetica, Geometria, Proportioni et Proportionalita - In 1494, Pacioli published this comprehensive work on arithmetic, geometry, and algebra. It included the first known description of double-entry bookkeeping, a fundamental concept in modern accounting. In Pacioli's book, he introduces the double-entry accounting system-in which for every debet dare (should give) there exists a debet habere (should have or should receive). Modern bookkeeping systems are still based on principles established in the 15th century, although they have had to be adapted to suit modern conditions. In Summa, the memorandum is the book where all transactions are recorded, in the currency in which they are conducted, at the time they are conducted. The memorandum, prepared in chronological order, is a narrative description of the business's economic events. The memorandum is necessary because there are no documents to support transactions. The second book, the journal, is the merchant's private book. The entries made here are in one currency, in chronological order, and in narrative form. The last book, known as the ledger, is an alphabetical listing of all the business's accounts along with the running balance of each particular account. CHAPTER 2: Fundamental Concepts in Accounting FUNDAMENTAL CONCEPTS Several fundamental concepts underlie the accounting process. In recording business transactions, accountants should consider the following: 1. Entity Concept - The most basic concept in accounting is the entity concept. An accounting entity is an organization or a section of an organization that stands apart from other organizations and individuals as a separate economic unit. Simply put, the transactions of different entities should not be accounted for together. Each entity should be evaluated separately. 2. Periodicity Concept - An entity's life can be meaningfully subdivided into equal time periods for reporting purposes. It will be aimless to wait for the actual last day of operations to perfectly measure the entity's profit. This concept allows the users to obtain timely information to serve as a basis on making decisions about future activities. For the purpose of reporting to outsiders, one year is the usual accounting period. 3. Stable Monetary Unit Concept - The Philippine peso is a reasonable unit of measure and that its purchasing power is relatively stable. It allows accountants to add and subtract peso amounts as though each peso has the same purchasing power as any other peso at any time. This is the basis for ignoring the effects of inflation in the accounting records. 4. Going Concern - Financial statements are normally prepared on the assumption that the reporting entity is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the entity has neither the intention nor the need to enter liquidation or to cease trading. This assumption underlies the depreciation of assets over their useful lives. The COVID19 pandemic continues to cause significant deterioration in economic conditions for many entities worldwide. The economic uncertainties may cast doubt on the entity's ability to continue as a going concern. CRITERIA FOR GENERAL ACCEPTANCE OF AN ACCOUNTING PRINCIPLE Accounting practices follow certain guidelines. GAAP, which stands for generally accepted accounting principles, encompass the conventions, rules and procedures necessary to define accepted accounting practice at a particular time. Accounting principles are established by humans. Unlike the principles of physics, chemistry, and the other natural sciences, accounting principles were not deduced from basic axioms, nor can they be verified by observation and experiment. Instead, they have evolved. This evolutionary process is going on constantly; accounting principles are not eternal truths. The general acceptance of an accounting principle usually depends on how well it meets three criteria: relevance, objectivity and feasibility. Financial Accounting and Reporting (FAR) BCC-FAR | A.Y. 2024 - 2025 Prof. Kenneth B. Pedrajas, CPA, CTT  1. A principle has relevance to the extent that it results in information that is meaningful and useful to those who need to know something about a certain organization. 2. A principle has objectivity to the extent that the resulting information is not influenced by the personal bias or judgment of those who furnish it. Objectivity connotes reliability and trustworthiness. It also connotes verifiability, which means that there is some way of finding out whether the information is correct. 3. A principle has feasibility to the extent that it can be implemented without undue complexity or cost. These criteria often conflict with one another. In some cases, the most relevant solution may be the least objective and the least feasible. BASIC PRINCIPLES In order to generate information that is useful to the users of financial statements, accountants rely upon the following principles: 1. Objectivity Principle - Accounting records and statements are based on the most reliable data available so that they will be as accurate and as useful as possible. Reliable data are verifiable when they can be confirmed by independent observers. Ideally, accounting records are based on information that flows from activities documented by objective evidence. Without this principle, accounting records would be based on whims and opinions and is therefore subject to disputes. 2. Historical Cost - This principle states that acquired assets should be recorded at their actual cost and not at what management thinks they are worth as at reporting date. 3. Revenue Recognition Principle - Revenue is to be recognized in the accounting period when goods are delivered or services are rendered or performed. 4. Expense Recognition Principle - Expenses should be recognized in the accounting period in which goods and services are used up to produce revenue and not when the entity pays for those goods and services. 5. Adequate Disclosure - Requires that all relevant information that would affect the user's understanding and assessment of the accounting entity be disclosed in the financial statements. 6. Materiality - Financial reporting is only concerned with information that is significant enough to affect evaluations and decisions. Materiality depends on the size and nature of the item judged in the particular circumstances of its omission. In deciding whether an item or an aggregate of items is material, the nature and size of the item are evaluated together. Depending on the circumstances, either the nature or the size of the item could be the determining factor. 7. Consistency Principle - The firms should use the same accounting method from period to period to achieve comparability over time within a single enterprise. However, changes are permitted if justifiable and disclosed in the financial statements. -------------------------------------------------- End of discussion ------------------------------------------------------- Reference: Basic Financial Accounting and Reporting (Made Easy) by Win Ballada (2022 issue – 24th Edition) Financial Accounting and Reporting (FAR) BCC-FAR | A.Y. 2024 - 2025 Prof. Kenneth B. Pedrajas, CPA, CTT