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Fundamentals of Accounting 1
Introduction

Business – is an organization from the largest and diversified corporation to a small sari-
sari store in the community which engages in generating revenues through the
manufacture and/or sale of goods or rendering services with the goal of earning a profit.

Forms of Business Organization:

1. Sole or Single Proprietorship – a business enterprise owned by one person.

2. Partnership – is an association of two or more persons who contribute money,
property, or industry to a common fund with the intention of dividing the profits
(or losses) among themselves.
3. Corporation – is an artificial being created by operation of law, having the right of
succession and the powers, attributes and properties expressly authorized by law
or incident to its existence
- a corporation can be formed by at least five (5) but not more than fifteen
(15) persons which will be called as incorporators.
4. Cooperatives - is an organization established for the purpose of purchasing and
marketing the products of its members, and/or procuring supplies for resale to the
members, whose profits are distributed to the members in the form of patronage
dividends.

Nature of Business Activities:

1. Service – business of this type renders service to the customers for a fee to
generate income. (e.g. barber shops, banks, public utilities, computer rental shops,
theaters, golf courses, hospitals, schools, etc)

2. Merchandising – refers to wholesalers or retailers who buys goods and offer them
for sale to customers at a price high enough to cover its cost and expenses and the
generation of net profit. (e.g. supermarkets, department stores, lumber and
hardware stores, record bars, sari-sari stores, etc.)

3. Manufacturing – a kind of business wherein they have to buy raw materials and
these same raw materials are processed and converted into finished products, and
then sell it to dealers, wholesalers, retailers or may sell it directly to ultimate
consumers. (e.g. cottage and furniture industries, paper mills, car manufacturers,
food processors and canneries, etc.)

Accounting Defined

1. 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.
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2. Accounting is an 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.

3. Accounting is the process of collecting, analyzing and communicating economic

information to permit informed judgment and decision by users of the
information.

4. Accounting is the process of collecting, analyzing, and reporting information stated

in monetary terms, reflecting the financial condition of a business enterprise.

Two Major Areas of Concentration of Accounting:

1. Managerial Accounting
- focuses primarily in forecasting the future of the business.
- it deals in the process of preparing reports intended for the use by the
management in directing or conducting a day to day operations and in
planning future activities.
- the reports are not made available to outside parties, hence, the
preparation is not governed by generally accepted accounting principles.
- the reports are prepared in a format that is most useful for management.

2. Financial Accounting
- deals with historical or past events.
- focuses primarily in the process of recording business transactions,
developing these transactions into set of financial reports, these reports are
the financial statements that are prepared according to generally accepted
accounting principles.

Users and their needs of Accounting Information

1. Owners. They are concerned mainly with the security of their investment with the
expectation that funds invested will generate positive returns.

2. Managers. They are responsible in the preparation of the financial reports, in

evaluating results of economic decisions made in the past, setting objectives
concerning sales, production, and profit levels.

3. Creditors. Financial institutions like banks extend credit to the company to finance
special projects or for its use in operations. Goods and services may also be
provided by the suppliers on credit terms. These creditors are interested in the
company’s ability to pay its debts as they become due.

4. Government Agencies. Business organizations are required to submit financial

information to taxing authorities to determine variety of taxes.
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Generally Accepted Accounting Principles (GAAP)

- the preparation of financial statements is based on rules or guidelines

which had received general acceptance within the business community and
the accountancy profession as well.
- nowadays, these principles are referred to as statement of financial
accounting standards (SFAS)

The following are some of the more important and generally accepted standards,
concepts and assumptions:

1. Entity Concept. A business is treated as a separate entity, distinct and apart from
its owner or owners. Any business enterprise is viewed as an individual accounting
unit, separate and distinct from the owner, or owners, as well as the other
businesses of the same owner.

2. Going Concern. It is assumed that the business entity will continue its existence
indefinitely unless there is evidence to the contrary. This concept supports the
historical cost principle as basis for measurement, which means that asset
acquired be carried or reported at acquisition cost rather than at current market
values. However, if the business is about to be sold or liquidated, the current
market values become more useful, relevant, and informative.

3. Historical Cost. When a transaction results in the acquisition of an asset, it should

be carried or reported at exchange price or simply the cost, and should not be
changed to market value even as time passes. In doing so, the asset value is
changed on the basis of mere offers, appraisals, and opinions, accounting reports
would soon become unstable and unreliable.

4. Matching Principle. The result of business operation is a vital information required

by the owners of the business. The proper determination of periodic net income is
achieved if there is a proper matching of revenues and expenses. The proper
matching can be done if accrual method of accounting is employed. The accrual
method states that all revenues should be recognized at the time the revenue is
earned regardless of when the revenue is collected and that all costs and expenses
should be recognized at the same time the expenses are incurred regardless of
when the expenses are paid.

5. Periodicity. Also known as the time period assumption. Since business entity is
assumed to be a going concern, it is necessary to divide its life into specific time
periods as a basis in preparing financial reports. Although financial statements are
usually prepared covering a period of one year, these reports can also be prepared
monthly, quarterly, or at any other time intervals which maybe useful for the
entity’s successful business operation. Financial statements prepared covering a
period of less than one year is known as interim financial statements.
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6. Objectivity. Transactions must be analyzed and recorded on the basis of objectivity

and bias-free verifiable evidence such as invoices, official receipts, vouchers,
freight bills, utility necessary as in the case of estimating the collectibility of
accounts receivables and the useful lives of depreciable assets, or possible liability
for product warranties, such as estimates should also be supported by objective
analysis like the company’s past experiences and by other companies which belong
to the same industry. Failure to comply with this principle, the confidence of the
many users of the financial statements could not be maintained.

7. Materiality. An item is considered as material or important if there is reason to

believe that knowledge of it would influence the decisions to be made by the user
of the financial statements. Two factors may be considered in determining
whether an item is material or not: 1) the relative size of the item as compared to
significant figures in the report, and 2) the nature of the items involved. It is to be
emphasized that what is a significant or material item that should be disclosed is a
matter of judgment, precise criteria cannot be applied. An item that is immaterial
to a large enterprise may be significant or material to a small one.

8. Conservatism. This means that in selecting alternatives, accountants have to

choose the one that has the least effect on the owner’s equity. Probable or loss is
to be recognized while probable gain is not. “Anticipate no profit and provide for
all losses” is a quotation expressing principle of conservatism.

9. Consistency. It is a common practice by the users of financial statements to

compare an enterprise’s current income statement and balance sheet with the
statements of the previous year or years. The primary basis of comparability is the
consistent application of principles and procedures from one period to another.
Consistency does not mean however, that no change in accounting method could
be made. If a new and better way of reporting is discovered, a change can be
made. However, the change in methods and its effect on the financial statements
must be clearly disclosed.

10. Adequate Disclosure (Completeness). This means that all relevant or important
facts which might influence or affect the decisions to be made by the user of the
financial statements should be disclose or completely stated in the aid financial
statements. Completeness may be achieved by using footnotes or parenthetical
notation to the financial statements. Most of the time that a separate statement,
called “Notes to the financial statements”, is prepared to clarify obscure or unclear
points.