INTRODUCTION TO ACCOUNTING

Lesson Objectives
At the end of this chapter, the students should be able to:
1. Define accounting;
2. Describe the nature of accounting;
3. Explain the functions of accounting in business;
4. Narrate the history or origin of accounting, and
5. Cite specific examples in which accounting is used in making business
decisions.

What is Accounting?

it is the systematic process of measuring and reporting relevant financial

information about the activities of an economic organization or unit

its underlying purpose is to provide financial information capable of being

expressed in monetary terms
Example: The sale of cars is identified as an economic event
that affects the company

How does it affect the company?

The sale of cars is identified as an economic event

> Anyone can identify the economic events relevant to the business based on the
example about Toyota sale of cars?

Examples of relevant economic events of Toyota sale of cars:

1. Sale of Toyota cars

2. Provision of services

3. Payment to suppliers

4. Purchase of equipment for the manufacturing company who produced

products

**to be identified as a relevant economic event, there should be a transfer of

things with value

The next step in the accounting process is the recording of relevant economic
events after the company identifies the relevant economic events

Those recorded events will serve as the history of its financial activities

In recording the relevant economic events should be done systematically and

chronologically for easier tracking and interpretation

THE NATURE OF ACCOUNTING

1. Accounting is a systematic process

Process is a series of actions that produce something or that lead to a

particular result
Ex: Opening of a business

The four aspects of Accounting

1. Recording- writing down of business transactions chronologically in the books

of accounts as they transpire

2. Classifying- sorting similar and related transactions into the five categories of
assets, liabilities, and owner’s equity, income and expenses

3. Summarizing- preparing the financial statements from the transactions

recorded in the books of account that are designed to meet the information needs
of its users

4. Interpreting- representing the qualitative and quantitative of financial

information about the business transactions

Ex: Buying and selling of items

> by interpreting the financial reports--users are able to determine the financial
standing of the company as well as the stability and growth potential

2. Accounting as an ART

Art- is a skill acquired by experience, study or observation or it is also

defined as an occupation requiring knowledge or skill

3. Accounting is a service activity

Service- is the occupation or function of serving

Activity- is something that is done as work or for a particular purpose

FUNCTIONS OF ACCOUNTING

The American Institute of Certified Public Accountants (IACPA), they define

ACCOUNTING as 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 results thereof.

From the foregoing definitions, the main functions of Accounting can be

summarized as follows:

1. Keeping a systematic record of business transactions. Recording transactions

does not only involve entering the transactions in the accounting books but the
record should be systematic enough to enable easy understanding of readers.

2. Protecting properties of the business. The accounting records serve as the

evidence that properties of a business do exist or how much of a particular
resource a company has. If the accounting records show that the amount of cash
should be P1,000,000, any excess and deficiency will be noticed immediately.
The accounting system helps in preventing employee fraud and misappropriation
of company resources.
3. Communicating results to various parties in or connected with the business.
The accounting reports produced at the end of each period are not only used by
external parties (like: potential investors, government agencies, etc) but also by
the management in their decision-making function. Communication of the results
of operations of a company is essential for all concerned parties to enable them
to make well-informed decisions.

4. Meeting legal requirements. In the Philippines, the government requires some

companies (particularly those with public accountability) to provide financial
reports quarterly, semi-annually or annually. This procedure aims to protect the
public by providing them the necessary information to make sound decisions.
The government also requires reports from heavily regulated industries such as
the energy and oil industries.

HISTORY OF ACCOUNTING
Ancient Accounting in Egypt, Mesopotamia, Greece and Rome

The history of accounting dates back to ancient times. Abacus which

functioned as a calculator in ancient times, was developed by the Summarians in
5,000 BCE followed by papyrus

and was developed by ancient Egyptians in 4,000 BCE. The papyrus not only
allowed recording of commercial transactions but also the transcription of
religious text, music, literature and more.

In Egypt, archaeologist Dr. Gunter Dreyer of the German Institute of

Archaeology unearthed clay tablets – considered to be among the oldest written
tax accounting records.

In the tomb of King Scorpion I in Egypt, he discovered old stone labels

believed to date back to 3,000 BCE around 5,300 years ago. These old stone
labels – were complete with marks representing accounts of oil and lines which
were believed to be paid to the king as taxes.

Mesopotamia had clay tokens

and clay tablets – to record their loans, herds, crops and system of trade. The
scribes who performed extensive duties in writing and recording in the
Mesopotamian civilization are the equivalent of present-day accountants. Aside
from writing down commercial transactions, scribes assured that the agreements
were in compliance with the detailed code requirements for commercial
transactions.
The Greeks also made significant contributions to the development of
accounting. In 600 BCE, they introduced money in the form of coins. They
adopted the Phonician writing system and invented a Greek alphabet-

which they used to facilitate record-keeping. As early as those times, bankers in

Greece offered credit and helped people transfer funds to banks.

The Romans introduced the use of an annual budget which coordinated

estimated revenues and taxes paid by the citizen in relation to the nation’s
expenditures. A cash book

was maintained by households for their expenses.

In England, William the Conqueror took possession of all properties in the
name of the king upon his invasion. In 1086, the Domesday Book

contained all the real estate surveyed by William the Conqueror and the taxes due
to them. To date, the Pipe Roll or the Great Roll of the Exchequer –

is the most ancient surviving accounting record in the English Language. This
contains the yearly accounting of rents, fines and taxes due to the King of
England, from 1130 to 1830.

14th Century – The Birth of Double-Entry Bookkeeping

During the 14th century, Luca Pacioli of Italy,

otherwise known as Friar Luca dal Borgo, a mathematician, friend and

contemporary of Leonardo da Vinci and considered to be the “Father of
Accounting”wrote Summa de Arithmetica, Geometria, Proportioni et
Proportionalita (Everything about Arithmetic, Geometry and Proportion). One
section of this book, De Computis et Scripturis (Of Reckonings and Writings) is
composed of 36 short chapters that describe bookkeeping. The accounting cycle,
similar to the modern day accounting cycle is also included in this book. It also
explains the extensively used balance sheet of today , the method of using
memorandums, journals and ledgers, the use of accounts such as assets,
liabilities, owner’s equity, revenue and expenses, year-end closing entries and
the use of the trial balance to prove a balanced ledger.

Luca Pacioli credited Benedetto Cotrugli, for the original idea of the
double-entry bookkeeping. Cotrugli’s manuscript of Della Mercatura et del
Mercante Perfetto (Of Trading and the Perfect Trader), which contains a brief
description of the double-entry of bookkeeping, was never printed. Not only Luca
Pacioli, but the Italians are broadly recognized to be the Father of Accounting for
their marked contribution to the improvement of trade and commerce. The
business-minded early capitalistic Venetian merchants used a double-entry
system of recording in the late 15th century to calculate earnings and profits.

19th Century – The Dawn of Modern Accounting in Europe and America.

Domination of the Theories of accounts (rather than accounting theories) marked
not only the beginning but also the latter part of the
19th century. In England, the Industrial Revolution

amounts of British capital were invested in flourishing industries in the United

States, Scottish or British chartered accountants were sent to the United States
to audit British investments. Some of these accountants decided to stay in which
replaced hand tools with machine or power tools, otherwise known as the factory
system, transformed accounting into an actual profession. Businesses continued
to expand, requiring the expertise of accountants to gain corporate control of
their flourishing businesses.

In Scotland, Queen Victoria granted a royal charter to the Institute of

Accountants in Glasgow on July 6, 1854, thereby creating the profession of
chartered accountant. Thus, accounting became a formal profession. In the latter
part of the 19th century , because large America and became provenancers of
various accounting firms which they set up to practice their profession. The year
1887 saw the birth of the first national US accounting society. The American
Association of Public Accountants which provided a formal certification process
for accountants was the predecessor of the present American Institute of
Certified Public Accountants (AICPA).

20th Century – The Evolution of Modern Accounting Standards

The American Institute of Certified Public Accountants (AICPA) , the first national
professional association for Certified Public Accountants (CPA) , was formed in
the young but prosperous nation of the United States. Because of the economic
depression, the Securities and Exchange Commission (SEC) was formed.
Periodic reports vouched by certified public accountants were filled by all
publicly - companies who had to register with the SEC before selling securities to
the public. Thus, the AICPA was tasked to set the accounting and auditing
standards for these reports until the establishment of the Financial Accounting
Standards Board (FASB) in 1973. The FASB is the result of the demand for more
reliable and comparable financial reporting by the Congress and SEC. Thus, the
FASB and the Governmental Accounting Standards Board (GASB) are currently
two of the significant authorities establishing the generally accepted accounting
principles (GAAP) in the US. On the other hand, in response to the continuing
expansion of business , large accounting firms offered consultancy services
aside from their auditing function.
The Information Age

The Information Age, otherwise known as the Computer Age, Digital Age, or New
Media Age, has brought about a significant change in the workload of
accountants. Manual, tedious and time-consuming tasks were replaced by faster
and more accurate computer methods. Transactions can be consummated online
with the help of the internet. Various software applications in accounting have
been developed to expedite procedures and accommodate the numerous needs
and demands of the different businesses.

21st Century – Accounting In the Modern Time

The 21st century opened with the replacement of the International Accounting
Standards Committee (IASC) by the International Accounting Standards Board
(IASB) established in January 2001. In the same year, the Enron Scandal, the
greatest corporate fraud case recorded in American history, caused Arthur
Andersen, one of the top audit firms in the United States to Act, was passed by
the US Congress in 2002 . This imposed tougher restrictions on accountants
conducting consultancy services. The year 2008 witnessed tougher times with
the economic recession in the United States. In response to the Great Recession,
the Dodd- Frank Act was signed into federal law on July 21 , 2010. This contains
sixteen major areas of reform, including Financial Stability, Orderly Liquidation
Authority, Transfer of Powers to the Comptroller, the FDIC , and the Fed,
Regulation of Advisers to Hedge Funds and Others, Insurance, Improvements to
Regulation, Wall Street Transparency and Accountability, Payment, Clearing and
Settlement Supervision, Bureau of Consumer Financial Protection, Federal
Reserve System Provision Improving Access to Mainstream Financial
Institutions, Pay It Back Act, Mortgage Reform, and Anti-Predatory Lending Act.

With constant development in modern technology and the globalization of

businesses, accountants continue to cope up with the changing trends. Many
countries including the Philippines have adopted the International Accounting
Standards (IAS) and the International Financial Reporting Standards (IFRS) in
order to support comparability and understandability of financial statements
across the globe. As a result, the accountants of today face greater and more
complicated responsibilities. In addition, technology today reduces the time,
effort, and cost of recordkeeping, minimizes errors as well as processes, and
summarizes with the latest innovations affecting their profession.

3. USERS OF ACCOUNTING INFORMATION

Learning Objectives:
At the end of the chapter, the students should be able to:
1. Define external users of accounting data and give examples;
2. Define internal users of accounting data and give examples.

INTRODUCTION
To be successful, businesses must interact with countries,
customers, investors, creditors and other groups. There is no known
business that is established just to transact with itself. The external users
are the main sources of income and/or funds that are key factors in
determining if a business will be profitable or not. Given the importance of
building lasting relationships with these groups, how can business
continue to capture the interest of such groups?
However, it is a common misconception that the users of accounting
information include only outside parties. This is clearly not the case. After
all, the success of a business is also heavily dependent on the people
running it.

WHAT ARE EXTERNAL USERS?

External users are secondary users of financial information who are
parties outside the company.
> they may not be directly involved in the company’s operations but
their decisions may significantly affect the business entity.

WHO ARE THE EXTERNAL USERS?

1. CUSTOMERS- are the main source of income of businesses. It can be
people or entities that acquire goods and services for a fee.
> they may not be directly involved in the company’s operations but
their decisions may significantly affect the business entity.

As an individual, in what way can you consider yourself as a customer?

Few examples might be of the following:
a. Buying shampoo in a nearby sari-sari store or buying the groceries or
supermarket
b. Having your haircut by the local barber
c. Eating your snacks in refreshment parlor
d. Availing the services of PLDT, GLOBE, ILPI or NAWASA

It is important to point out that even large businesses can be customers

also. In what situations can large businesses be customers also?
Example: Most restaurants do not raise livestocks for their own use,
instead they purchase dressed chicken, beef, pork and other livestock
products.
Why is it that customers (the restaurants) are interested in the accounting
information of a business?
By analyzing the accounting information of a business, customers
can determine if it will be profitable for them to transact with the business.
> especially important if the customer plans to build a long-term
relationship with the business.
> like for example--if their suppliers of dressed chicken, beff, pork and
others are having financial difficulties or a tract record of being
unreliable---of course the restaurant (being their customer) will NO longer
ask their services to supply them.
> if a company is continuously showing losses in its financial statements--
it might indicate that the products and services provided by the company
are NOT of high quality.

Illustrative Example: Patricia plans to organize a furniture shop. It was her

business to take off by building the furniture from scratch. However, the
materials needed to build the furniture will be purchased from an outside
supplier. Patricia has two possible suppliers, namely: Dyana Company and
Dray Company.
For the last 5 years, Dyana Company and Dray Company displayed
positive income in their financial statements with Dray Company having a
slightly higher income on the average than Dyana’s Company. Both
companies are regarded as reliable suppliers.
But during the last year, Dray Company experienced problems in its
operations due to a labor strike preventing them from fulfilling all orders.
What company should Patricia choose as her supplier?
EXTERNAL USERS OF ACCOUNTING INFORMATION
2. CREDITORS- Lend their resources (usually money) to the business
in exchange for a fee.

Why do we need creditors like banks, lending institutions, wealthy

individuals and even the government?

> Most large businesses or even small businesses - require additional funds to
operate the business. The contribution of the owners or investors is the fuel that
drives the company forward or going on. When the fuel runs out, the business
must find a new source of funds. And the possible sources of additional funds
are the creditors. We also have to know that money loses its value over time.

Example: The value of P1,000 in 2020 is not equal to the value of P1,000 in 2021.
> This is the main reason why creditors like banks and others ask for a fee
in the form of interest--when the borrower uses their money.

Does business borrow money immediately from the creditors?

> First, examine its financial statements. The biggest fear of creditors like
banks--they cannot collect the amount due to them. High interest rates may
creditors charge--it will not matter if at the end, they cannot collect the amount.
Creditors would not lend to a risky company--however, there are banks who still
offer their money to these companies in exchange for higher interest rates. As a
rule of thumb in the field of finance, “high risk, high return”.
Creditors on the other hand ordinarily observe the profits of a company.
> they are after if they can repay, also whether they don’t fail to pay their
debts.
> to consider also the level of profits, the amount of borrowings of the
company.
> high profit is not much if the company still have huge amount of debts

Example: If the profit of A Company for 2016 totalled P2,000,000 and its
demandable debt amounts to P3,000,000--there is still a chance that a creditor will
not get paid.

The three (3) main factors considered by creditors before lending to a company:
1. Riskiness of lending
2. Profitability of the company
3. Company’s amount of borrowings

Illustrative Problem:
Amadeo Company, a textile manufacturer, submitted a proposal to
Philippine Rural Bank (PRB) which states that the company plans to borrow
P5,000,000 payable two (2) years from now. Amadeo Company also promises to
pay interest of P150,000 every six (6) months. PRB examined Amadeo’s Company
financial statements. Based on the bank’s analysis, they formed the following
conclusions:
1. The profit of Amadeo Company grew by an average of 10% each year for
the past three years.
2. Amadeo Company only has a small amount of borrowings
3. Amadeo Company never defaulted on its borrowings in the past.

Question: Does Philippine Rural Bank lend money to Amadeo Company? Yes or
No, state your reasons
3. POTENTIAL INVESTORS
> put their resources (usually money)in a business hoping to earn a
decent amount of return

The difference between potential investors and creditors:

1. The potential investors, for they they take the risk, they normally could
earn more profits than creditors

2. Enjoy no limit on the amount of profits they can receive-- if the company
they had invested is doing well

> but if the company they had invested incurred losses, they might even
lose everything they had invested, while Creditors- they earn fixed amount
of profits in the resources they lend (interests and fees)

Why are financial reports of a company important to investors?

> investors are even more afraid than creditors--they will lose their money
if the company becomes insolvent

> creditors are paid first before the investors

Illustrative example: Aryana is a successful career woman. During her 15-

year tenure as an engineer, she amassed a total of P10M in savings.
Instead of placing her money in the bank, which earns only a 2% interest
every year, she plans to invest in either Shell or Petron. Shell and Petron
are two of the largest companies in the country. After analyzing the
financial statements of both Companies, Aryana noted that Petron and
Shell earned high levels of profit for the past two years with Petron
garnering P40M more in profits. In addition, Petron is planning to expand
the business which is expected to bring more profits for the company.

Question: What company does Aryana invest her money in?

4. GOVERNMENT

> an external user whose primary role is to regulate businesses

> studies financial statements to determine amount of taxes payable

> oversee business operations with the end goal of improving the
economy; checks the accuracy of the financial statements to compute for
the correct amount of taxes payable

5. ACADEME

> uses accounting information primarily for academic purposes

> uses accounting information in the teaching of accountancy;

researches loopholes and possible improvements in the field of
accountancy.
6. GENERAL PUBLIC- citizens and residents of the country even though
they do not plan to transact with the business;

> use financial statements to gauge the condition of the economy

> concerned with the overall performance of the economy, use financial
information to estimate economic performance

B. INTERNAL USERS OF ACCOUNTING INFORMATION

1. Management

2. Employees

3. Owners or stockholders

1. MANAGEMENT- this is composed of employees within the

company that can implement, middle-level managers,
supervisors are the common classes of employees belonging to
the management group

> we will collectively refer to them as “managers”

> authority to make judgements for the company

2. EMPLOYEES - they use the financial statements primarily for

personal use;

> concerned with the company’s profitability, WHY?

3. OWNERS OR STOCKHOLDERS - they are the existing investors

of the company

> they already invest their resources in the company, take an

active role in the management of the business