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CHAPTER 1
Concepts
& Principles
DEFINITION OF ACCOUNTING
Accounting is a service activity. Its function is to provide quantitative information primarily financial in nature, about economic entities that is intended to be useful in making economic decisions. (FRSC) Accounting is 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. (AICPA) Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information. Accounting is an information system that measures, processes and communicates financial information about an identifiable economic entity. Accounting is the language of business. It is the medium for reporting financial information about a business entity to many different users of financial statement needed in making economic decisions.
Corporation It is treated as an artificial being created by operation of law, having the right of succession and the powers, attributes and properties expressly authorized by law (Section 2, Corporation Code). Owners of corporations are called stockholders or shareholders. This is type of business organization common to large companies operating in different industries.
Examples: San Miguel Corporation Jollibee Foods Corporation SM Prime Corporation
Although they differ in type of owners, features and domestic laws applied, accounting procedures used in recording transactions and preparing financial statements for these forms are largely the same. These organizations are separate and distinct entities from its owners, whether proprietor, partner or stockholder. Therefore, records of business transaction of the organization should not include owners personal records of transactions. The choice of form of business organization depends on different factors such as nature of the business entity, capital requirement for operation or a requirement set by the laws.
Manufacturing These companies acquire raw materials to produce goods and then sell these to customers which are usually the entities in merchandising activity.
Examples: Apple Corporation Coca-Cola Company Asia Brewery Sugar manufacturers
Lenders They need information that enables them to determine whether their loans and its interest earned will be paid when due.
Illustration: Banco San Juan requires clients applying for loans to submit financial statements to assess their ability to pay.
Customers They have interest in the information about the continuance of an entity, especially when they have a long-term involvement with, or are dependent on the entity
Illustration: Oil consumers, especially those in business activities, gathered data on the financial stability of ONE Gas Company, the sole oil provider in Batanes.
Employees They are interested in the information about the profitability and stability of their employers. They are also interested in employers ability to provide their remuneration, retirement benefits and employment opportunities.
Illustration: Labor union protests after financial information about their employer revealed that it is near insolvency.
Government and its agencies The government and its agencies are interested in the allocation of resources and therefore the activities of entities. They also require information to regulate the activities of entities, determine taxation policies and to use as basis for national income and related statistics.
Illustration: Bureau of Internal Revenues require individuals and entities to submit income tax return to determine the amount or level of tax to be imposed.
Public Financial statements may assist the public by providing information about the trends and recent developments in the prosperity of the entity and the range of its activities.
FUNDAMENTAL CONCEPTS
Entity Concept This is the most basic concept in accounting. It states that transactions of different entities should be accounted and evaluated for separately. Personal records of transactions of the owners should not be mixed up with the records of the business entity.
Illustration: Mr. Asther Soriano, owner of Tapsi ni Papsi, acquired kitchen equipment for the business entity. It is proper to record the acquisition of the assets in the books of the business entity. Illustration: Mr. Asther Soriano, owner of Tapsi ni Papsi, bought a service vehicle for personal use. The acquisition should be recorded in his personal books rather than the books of business entity.
Periodicity Concept This concept suggests that life of the business entities should be subdivided evenly into time periods usually called accounting periods. This would help the users of financial statement to easily evaluate and compare the financial position and financial performance of an entity from period to another period. This allows the users to obtain timely information for making economic decisions. For the purpose of presentation of financial statements, accounting periods are commonly equivalent to 12 months or one year.
Stable Monetary Unit Concept This concept ignores the effect of inflation in the accounting records. This allows accountants or bookkeepers to easily subtract or add peso amounts from one period to another period assuming the purchasing power of peso remained the same.
Expense Recognition Principle Expenses should be recognized when incurred (when goods are consumed, used or expires, or when services are received) rather than when cash is paid to the providers of services or suppliers of goods.
Illustration: Lions Merchandising received an electric bill from Green Dragons Electric Company which it intended to pay next month. Though no cash is paid to Green Dragons, Lions should recognize expense incurred because electricity has already been used or consumed by Lions evidenced by the electric bill.
UNDERLYING ASSUMPTION
Going Concern Financial statements should be presented with the assumption that the entity being reported will continue its business operation indefinitely, otherwise explicitly stated by the management or owners.
To make its income statement looks good, the bookkeeper of GHI Company purposefully omitted P200,000 worth of expenses to increase its profit.
The illustrations above shows information not represented faithfully, thus, making the financial information not reliable for making economic decisions.
Neutrality Information contained in the financial statements should be free from bias.
Illustration: The owner of the KLM Services reported only the profitable months of operation and omitted the months the entity incurred losses.
Prudence It is the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities and expenses are not understated. It is well known as the principle of conservatism.
Illustration: Inventories are measured at lower of cost and net realizable value.
Balance Between Benefits and Cost The balance between benefit and cost is a pervasive constraint rather than a qualitative characteristic. The benefits derived from information should exceed the cost of providing it.