Chapter 1
Introduction to Business and Accounting
Read: Success Story: Henry Sy, Philippines Richest Man (2015). It tells the story
man behind the SM Prime Holdings. What are his sources of income? Why did he
become the richest man in the county? The article will open your eyes to the world of
business
Lesson 1: Nature of Business
Target Outcomes
At the end of the lesson, you are expected to:
1. define business;
2. discuss the goals of a business;
3. explain the forms of businesses according to organization;
4. identify businesses according to activities;
Abstraction
Business is defined as an organized entity that produce and sell products, and render
services with the goal of earning profit. This definition gives an overview of what is
business, although limited in scope. Profit is not the “be-all, end-all” enterprises
nowadays. Here are the goals of businesses:
The Goals of a Business
1. Profit Maximization
According to economist Milton Friedman, the main purpose of a business
is to maximize profits for its owners, and in the case of a publicly-traded
company, the stockholders are its owners. Others contend that a business’s
principal purpose is to serve the interests of a larger group of stakeholders,
including employees, customers, and even society as a whole. Anu Aga, ex-
chairperson of Thermax Limited, once said, “We survive by breathing but we
can’t say we live to breathe. Likewise, making money is very important for a
business to survive, but money alone cannot be the reason for business to exist.
”
2. Social Benefit
Many observers would hold that concepts such as economic value added
are useful in balancing profit-making objectives with other ends. They argue that
sustainable financial returns are not possible without taking into account the
aspirations and interests of other stakeholders such as customers, employees,
society and the environment. This concept is called corporate social
responsibility (CSR).
This conception suggests that a principal challenge for a business is to
balance the interests of parties affected by the business, interests that are
sometimes in conflict with one another. The emerging new mantra is to create
social progress as well as create profits. In a sense, corporate social
responsibility highlights the fact that business, consumers and society are part of
a shared ecosystem, and that the long-term health of this ecosystem must be
maintained above all else.
3. Innovation as a Goal
Rohit Kishore persuades that business can also be viewed to exist for the
purpose of creative expansion. Successful firms like Google manage to align
their activities towards the purpose of creative expansion from the perspective of
all stakeholders, especially employees. This also validates the growing
importance of innovation as a core principle for corporation survival and success.
4. Contract Theory
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Advocates of business contract theory believe that a business is a
community of participants organized around a common purpose. These
participants have legitimate interests in how the business is conducted and,
therefore, they have legitimate rights over its affairs. Most contract theorists see
the enterprise being run by employees and managers as a kind of representative
democracy.
5. Stakeholder Theory
Stakeholder theorists believe that people who have legitimate interests in
a business also ought to have voice in how the business is run. However,
stakeholder theorists take contract theory a step further, maintaining that people
outside of the business enterprise ought to have a say in how the business
operates. Thus, for example, consumers, even community members who could
be affected by what the business does (for example, by the pollutants of a
factory) ought to have some control over the business.
6. Business as Property
Some people believe that a business is essentially someone’s property,
and, as such, that its owners have the right to dispose of it as they see fit (within
the confines of the law and morality). They do not believe that workers or
consumers have special rights over the property, other than the right not to be
harmed by its use without their consent. In this conception, workers voluntarily
exchange their labor for wages from the business owner; they have no more right
to tell the owner how he will dispose of his property than the owner has to tell
them how to spend their wages. Similarly, assuming the business has purveyed
its goods honestly and with full disclosure, consumers have no inherent rights to
govern the business, which belongs to someone else.
Forms of Businesses
1. Sole/single proprietorship. A form of business is owned by one
person; the simplest, and the most common form of business organization.
The Department of Trade and Industry is the government agency that
regulates the trade names of sole/single proprietorship businesses.
Advantages of sole/single proprietorship
a. The owner keeps all the profits.
b. The owner makes all the decisions.
c. It is easy to form and operate.
Disadvantages of sole/single proprietorship.
a. The life of the business is limited to the life of the owner. Once the
owner dies, the business will cease to operate under the name of the
proprietor.
b. The amount of capital is limited only by the wealth of the proprietor.
2. Partnership- A form of business owned by two or more persons. The
details of the arrangement between the partners are outlined in a written
document called articles of partnership. Profits are divided among partners based
on their agreed sharing. The owner is called a partner.
Advantages of a partnership
• Higher capital because two or more persons will contribute to the
common fund.
• It is easy to operate like a sole/single proprietorship
Disadvantages of a partnership
• The profits are divided among the partners.
• A partner can be held liable for the acts of the other partners.
• In a lawsuit, the personal properties of the partners can be held
beyond their contributions and may be used to answer for any liability
of the partnership.
3. Corporation- A corporation is a business organized as a separate legal
entity (artificial person) under the corporation law with ownership divided into
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transferable shares of stocks. Emphasize that it is the law (Corporation Code of
the Philippines) that creates a corporation. The corporation begins its existence
from the date the Articles of Incorporation is approved by the Securities and
Exchange Commission (SEC). The SEC (Securities and Exchange Commission)
is the government agency primarily tasked to regulate private corporations in the
Philippines. The owners are called stockholders or shareholders. The word
‘Corporation/Incorporation/Corp./Inc.’ appears in the name of the entity. The
voting rights of a shareholder is generally based on the percentage of ownership.
The management of the business is delegated by the shareholders to the Board
of Directors. The ownership is divided into shares and the value of one share
may be denominated at a smaller amount, for example at PHP10 per share. The
proof of ownership is evidenced by a stock certificate.
Advantages of a corporation
• Can easily raise additional funds by selling shares of stocks to the public.
• Shareholders are not personally liable for the debts of the corporation. The
extent of their liability is limited to their equity (ownership) in the
corporation.
Disadvantages of a corporation
• It is relatively complicated to set up.
• Subject to several legal restrictions as listed in the Corporation Code of
the Philippines
4. Cooperatives- A cooperative is a duly registered association of persons
with a common bond of interest, voluntarily joining together to achieve their
social, economic and cultural needs. The owners are called members who
contribute equitably to the capital of the cooperative. The members are expected
to patronize their products and services. The word ‘cooperative’ appears in the
name of the entity. This form of business organization is regulated by the
Cooperative Development Authority (CDA).
Advantages of a cooperative
• Enjoys certain tax exemption privilege
• Promotes the concept of sharing resources
Disadvantages of a Cooperative
• Limited distribution of surplus
• Requires continuous education programs for members.
• The members have active and direct participation in the business of the
cooperative.
Types of business organizations
Types of business organizations differ on the presentation of the equity
side but the accounting for assets and liabilities are essentially the same
How does the following businesses earn profit?
• Bruno’s Barber Shop
• Kumon Tutorial
• United Royal Hotel
• Cynthia’s Food Vendor
• Susan’s Roses Flower Shop
• LavaDaks Laundry Shop
• Julie’s Bakery
• Reyes Haircutters
The nature of their operations, the presentation of their financial
statements statement of may differ from each other
3 types of business organizations:
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1. Service Business- This type of business offers professional skills, advice
and consultations.Examples: barber shops and beauty parlors, repair
shops, banks, accounting and law firms
2. Merchandising Business- This type of business buys at wholesale and
later sells the products at retail. They make a profit by selling prices that
are higher than their purchase costs. This type of business is also known
as "buy and sell". Examples are: book stores, sari-sari stores, hardware
stores
3. Manufacturing Business- This type of business buys raw materials and
uses them in making a new product, therefore combining raw materials,
labor and expenses into a product for sale later on. Examples are: shoe
manufacturing businesses, car manufacturing plants
There are businesses that may be classified under more than one type of
business. A bakery, for example, combines raw materials in making loaves of
bread (manufacturing), sells hot pan de sal (merchandising), and caters
customers’ orders in small coffee table servings of ensaymada and hot coffee
(service).
Lesson 2: Accounting Defined
Target Outcomes
At the end of the lesson, you are expected to:
1. define accounting;
2. discuss the nature of accounting and its function to business;
3. explain salient points in the history of accounting.
Abstraction
Accounting is the process of IDENTIFYING, RECORDING, and
COMMUNICATING economic events of an organization to interested users.”
(Weygandt, J. et. al)
Take
note
of
three
concepts about accounting in the picture above:
1. IDENTIFYING – this involves selecting economic events that are
relevant to a particular business transaction. The economic events
of an organization are referred to as transactions. Examples of
economic events or transactions - In a bakery business:
•sales of bread and other bakery products • purchases of flour that
will be used for baking• purchases of trucks needed to deliver the
products
2. RECORDING – this involves keeping a chronological diary of
events that are measured in pesos. The diary referred to in the
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definition are the journals and ledgers which will be discussed in
future chapters.
3. COMMUNICATING – occurs through the preparation and
distribution of financial and other accounting reports.
Nature of accounting
According to Accounting Theory: “Accounting is a systematic recording of
financial transactions and the presentation of the related information to
appropriate persons.” Based on this definition we can derive the following basic
features of accounting:
Accounting is a service activity. Accounting provides assistance to
decision makers by providing them financial reports that will guide
them in coming up with sound decisions.
Accounting is a process: A process refers to the method of performing
any specific job step by step according to the objectives or targets.
Accounting is identified as a process, as it performs the specific task of
collecting, processing and communicating financial information. In
doing so, it follows some definite steps like the collection, recording,
classification, summarization, finalization, and reporting of financial
data.
Accounting is both an art and a discipline. Accounting is the art of
recording, classifying, summarizing and finalizing financial data. The
word ‘art’ refers to the way something is performed. It is behavioral
knowledge involving a certain creativity and skill to help us attain some
specific objectives. Accounting is a systematic method consisting of
definite techniques and its proper application requires skill and
expertise. By nature, accounting is an art. And because it follows
certain standards and professional ethics, it is also a discipline.
Accounting deals with financial information and transactions:
Accounting records financial transactions and data, classifies these
and finalizes their results given for a specified period of time, as
needed by their users. At every stage, from start to finish, accounting
deals with financial information and financial information only. It does
not deal with non-monetary or non-financial aspects of such
information.
Accounting is an information system: Accounting is recognized and
characterized as a storehouse of information. As a service function, it
collects processes and communicates financial information of any
entity. This discipline of knowledge has evolved to meet the need for
financial information as required by various interested groups.
Function of accounting in business
Accounting is considered as the language of business. Accounting is the
means by which business information is communicated to business owners and
stakeholders. The role of accounting in business is to provide information for
managers and owners to use in operating the business. In addition, accounting
information allows business owners to assess the efficiency and effectiveness of
their business operations. Prepared accounting reports can be compared with
industry standards or to a leading competitor to determine how the business is
doing. Business owners may also use historical financial accounting statements
to create trends for analyzing and forecasting future sales.
Accounting helps the users of these financial reports to see the true
picture of the business in financial terms. In order for a business to survive, it is
important that a business owner or manager be well-informed.
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History of accounting
You may watch the History of Accounting; a four-minute video on the
development of accounting.
Accounting is as old as civilization itself. It has evolved in response to various
social and economic needs of men. Accounting started as a simple recording of
repetitive exchanges. The history of accounting is often seen as indistinguishable from
the history of finance and business.
Following is the evolution of accounting:
• The Cradle of CivilizationAround 3600 B.C., record-keeping was already common
from Mesopotamia, China and India to Central and South America. The oldest evidence
of this practice was the “clay tablet” of Mesopotamia which dealt with commercial
transactions at the time such as listing of accounts receivable and accounts payable.
• 14th Century - Double-Entry BookkeepingThe most important event in accounting
history is generally considered to be the dissemination of double entry bookkeeping by
Luca Pacioli (‘The Father of Accounting’) in 14th century Italy. Pacioli was much revered
in his day, and was a friend and contemporary of Leonardo da Vinci. The Italians of the
14th to 16th centuries are widely acknowledged as the fathers of modern accounting
and were the first to commonly use Arabic numerals, rather than Roman, for tracking
business accounts. Luca Pacioli wrote Summa de Arithmetica, the first book published
that contained a detailed chapter on double-entry bookkeeping.
• French Revolution (1700s)The thorough study of accounting and development of
accounting theory began during this period. Social upheavals affecting government,
finances, laws, customs and business had greatly influenced the development of
accounting.
• The Industrial Revolution (1760-1830)Mass production and the great importance of
fixed assets were given attention during this period.
• 19th Century – The Beginnings of Modern Accounting in Europe and America
The modern, formal accounting profession emerged in Scotland in 1854 when Queen
Victoria granted a Royal Charter to the Institute of Accountants in Glasgow, creating the
profession of the Chartered Accountant (CA). In the late 1800s, chartered accountants
from Scotland and Britain came to the U.S. to audit British investments. Some of these
accountants stayed in the U.S., setting up accounting practices and becoming the
origins of several U.S. accounting firms. The first national U.S. accounting society was
set up in 1887. The American Association of Public Accountants was the forerunner to
the current American Institute of Certified Public Accountants (AICPA).In this period,
rapid changes in accounting practice and reports were made. Accounting standards to
be observed by accounting professionals were promulgated. Notable practices such as
mergers, acquisitions and growth of multinational corporations were developed. A
merger is when one company takes over all the operations of another business entity
resulting in the dissolution of another business. Businesses expanded by acquiring
other companies. These types of transactions have challenged accounting
professionals to develop new standards that will address accounting issues related to
these business combinations.
• The Present - The Development of Modern Accounting Standards and
CommerceThe accounting profession in the 20th century developed around state
requirements for financial statement audits. Beyond the industry's self-regulation, the
government also sets accounting standards, through laws and agencies such as the
Securities and Exchange Commission (SEC). As economies worldwide continued to
globalize, accounting regulatory bodies required accounting practitioners to observe
International Accounting Standards. This is to assure transparency and reliability, and to
obtain greater confidence on accounting information used by global investors.
Nowadays, investors seek investment opportunities all over the world. To remain
competitive, businesses everywhere feel the need to operate globally. The trend now for
accounting professionals is to observe one single set of global accounting standards in
order to have greater transparency and comparability of financial data across borders.
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Lesson 3 : Users of Accounting Information
Target Outcomes
At the end of the lesson, you are expected to:
1. identify the users of accounting information;
2. discuss the type of information needed by the users; and
3. explain the decisions affected by accounting information.
Abstraction
Recall the definition of accounting and why accounting is considered as the
language of business.Accounting information helps users to make better financial
decisions.
In this lesson, we are going to identify who uses accounting data or information.
There are two broad categories of users of financial information: internal and external
users.
1. INTERNAL USERS
Internal users of accounting information are those individuals inside a
company who plan, organize, and run the business. These users are directly
involved in managing and operating the business. These include marketing
managers, production supervisors, finance directors, company officers and owners
Internal users (Primary Users) of accounting information include the following:
a. Management
o Information need: income/earnings for the period, sales, available
cash, production cost.
o Decisions supported: analyze the organization's performance and
position and take appropriate measures to improve the company
results. sufficiency of cash to pay dividends to stockholders; pricing
decisions
b. Employees
o Information need: profit for the period, salaries paid to employees
o Decisions supported: job security, consider staying in the employ of the
company or look for other employment opportunities
c. Owners
o Information need: profit or income for the period, resources or assets
of the business, liabilities of the business
o Decisions supported: considerations regarding additional investment,
expanding the business, borrowing funds to support any expansion
plans.
Accounting information is presented to internal users usually in the form of
management accounts, budgets, forecasts and financial statements. This information
will support whatever decision of the internal users.
2. EXTERNAL USERS
External users are individuals and organizations outside a company who want
financial information about the company. These users are not directly involved in
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managing and operating the business. The two most common types of external users
are potential investors and creditors. Potential Investors use accounting information to
make decisions to buy shares of a company. Creditors (such as suppliers and bankers)
use accounting information to evaluate the risks of granting credit or lending money.
Also included as external users are government regulatory agencies such as Securities
and Exchange Commission (SEC), Bureau of Internal Revenue (BIR), Department of
Labor and Employment (DOLE), Social Security System (SSS), and Local Government
Units (LGUs).
External users (Secondary Users) of accounting information include the following:
a. Creditors: for determining the credit worthiness of an organization. Terms of
credit are set by creditors according to the assessment of their customers'
financial health. Creditors include suppliers as well as lenders of finance such
as banks.
b. Tax Authorities (BIR): for determining the credibility of the tax returns filed
on behalf of a company.
c. Investors: for analyzing the feasibility of investing in a company. Investors
want to make sure they can earn a reasonable return on their investment
before they commit any financial resources to a company.
d. Customers: for assessing the financial position of its suppliers which is
necessary for them to maintain a stable source of supply in the long term.
e. Regulatory Authorities (SEC, DOLE): for ensuring that a company's
disclosure of accounting information is in accordance with the rules and
regulations set in order to protect the interests of the stakeholders who rely on
such information in forming their decisions.
Internal users of accounting information are those who are involved in planning,
organizing and running the business. They need more detailed information on a timely
basis in order to support their decisions. Examples of these internal users are
managers, employees and owners.
The external users of accounting information are those individuals or
organizations outside a company who are interested in its financial information.
Examples of these external users are potential investors, suppliers and government
agencies.
Lesson 4 : Accounting Concepts and Principles
Target Outcomes
At the end of the lesson, you are expected to:
1. enumerate the accounting principles;
2. discuss accounting concepts and principles; and
3. apply accounting concepts and principles in a business setting.
Abstraction
Consider the following case of Petness First Pet Shop
Juan dela Cruz opened his pet shop business called Petness First Pet Shop. He
opened a bank account for his business and deposited PHP500,000. The business
earned PHP50,000 but he had doubts with the recorded expense of PHP60,000. He is
not sure if he should include the following items as expenses:
Salary expense 20,000
Rent expense 10,000
Utilities expense (at home) 15,000
Utilities expense (at the store) 10,000
Insurance expense 5,000
Withdrawals 10,000
TOTAL 60,000
At the end of this lesson you must be able to identify the accounting principles
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and concepts violated in the above scenario.
Accounting concepts and principles
1. Business entity principle – a business enterprise is separate and distinct from
its owner or investor.
Example :If the owner has a barber shop, the cash of the barber shop should be
reported separately from personal cash.
The owner had a business meeting with a prospective client. The expenses that
come with that meeting should be part of the company’s expenses. If the owner paid for
gas for his personal use, it should not be included as part of the company’s expenses.
2. Going concern principle – business is expected to continue indefinitely.
Example: When preparing financial statements, you should assume that the
entity will continue indefinitely.
3. Time period principle – financial statements are to be divided into specific time
intervals. Example : Philippine companies are required to report financial
statements annually.
The salary expenses from January to December 2015 should only be reported in
2015.
4. Monetary unit principle – amounts are stated into a single monetary unit
Example :Jollibee should report financial statements in pesos even if they have a
store in the United States.
Google should report financial statements in dollars even if they have a branch
here in the Philippines
5. Objectivity principle – financial statements must be presented with supporting
evidence.Example :When the customer paid Jollibee for their order, Jollibee
should have a copy of the receipt to represent as evidence.
When a company incurred a transportation expense, a voucher should be
prepared as evidence.
6. Cost principle – accounts should be recorded initially at cost.Example :When
Jollibee buys a cash register, it should record the cash register at its price when
they bought it. When a company purchases a laptop, it should be recorded at the
price it was purchased.
7. Accrual Accounting Principle – revenue should be recognized when earned
regardless of collection and expenses should be recognized when incurred
regardless of payment. On the other hand, the cash basis principle in which
revenue is recorded when collected and expenses should be recorded when
paid. Cash basis is not the generally accepted principle today.
Example: When a barber finishes performing his services he should record it as
revenue. When the barber shop receives an electricity bill, it should record it as
an expense even if it is unpaid
8. Matching principle – cost should be matched with the revenue generated.
Example: When you provide tutorial services to a customer and there is a
transportation cost incurred related to the tutorial services, it should be recorded
as an expense for that period.
9. Disclosure principle – all relevant and material information should be reported.
Example:The company should report all relevant information.
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10. Conservatism principle – also known as prudence. In case of doubt, assets
and income should not be overstated while liabilities and expenses should not be
understated. Example: In case of doubt, expenses should be recorded at a
higher amount. Revenue should be recorded at a lower amount.
11. Materiality principle – in case of assets that are immaterial to make a difference
in the financial statements, the company should instead record it as an expense.
Example: A school purchased an eraser with an estimated useful life of three
years. Since an eraser is immaterial relative to assets, it should be recorded as
an
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