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INTRODUCTION TO ACCOUNTING
L Velasco / BA 99.1

Contents

What is Accounting? Types of Business Organizations Conceptual Framework

Users of Financial Information IFRS and GAAP Qualitative Characteristics Constraints Assumptions

The Accounting Equation The Financial Statements

What is Accounting?

The Language of Business Accounting is the art of communicating financial information about a business entity to users such as shareholders and managers.
The communication is generally in the financials form statements that show in money terms the economic resources under the control of management. The art lies in selecting the information that is relevant to the user and is reliable.

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What is Accounting?

Accounting is defined by the American Institute of Certified Public Accountants (AICPA) 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 financial character, and interpreting the results thereof."

Bottomline

Accounting is an information system how to gather important data, process them and report the processed data in such a way that it is easily understandable by the intended user. Accounting encompasses three main activities:
Identification of Economic events Recording Reporting and Analysis

Types of Business Entities

Sole Proprietorship Partnership Corporation

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Sole Proprietorship

A business organization where there is only one owner. The owner is also the manager of the affairs of the sole proprietorship. Suitable for small business and start-ups because of substantially less capital needed to put it up.

Characteristics of a Proprietorship

Separate entity with no continuous life Unlimited liability of owner Unification of ownership and management Business Taxation

Sole Proprietorship
Advantages

Disadvantages

Less regulations by government in operating decisions Flexibility in and simplicity of decision making.

Unlimited liability of the owner. Limited capital Limited management expertise specially if there are no other professional managers

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Partnership

In a contract of Partnership, two or more persons bind themselves to contribute money, property or industry to a common fund, with the intention of dividing the profits among themselves. The owners and the partnership are separate juridical entities. Partners are liable prorata to creditors of the Partnership.

Partnership
Advantages

Disadvantages

Appropriate for small number of people who want to contribute capital/services to a business. Not strictly regulated. Can be formed by merely forging a contract.

More complicated transfer of ownership. Limited funds from partners. Difficult to manage the affairs if there are too many partners.

Corporation

It is an artificial being created by law with a separate judicial personality from its owners. Governed by the BOD (Board of Directors) who acts as the stewards of the company in behalf of the shareholders.

Ownership exercised through stocks.

Managed by a separate group (called Management) who are not necessarily owners of the company.

Serves at the pleasure of the BOD

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Corporation
Advantages

Disadvantages

Suitable for large capital requirement businesses. Limited liability of owners/shareholders Easy transfer of ownership -- > stability in ownership

A lot of documentary requirements to set up. Heavily regulated by the government Fixed tax rate of 35% Agency Problem between the shareholders and management

Generally Accepted Accounting Principles

Set of standards that are used as basis in the preparation of financial statements. A set of accounting rules accepted by the profession. Sources:
Law Securities Regulations Code, Tax Authorities, Civil Code Standard-setting bodies Financial Reporting Standards Council/International Accounting Standards Board

International Financial Reporting Standards

Historically, different countries use their own accounting standards.

Difficult for investors to compare companies that operate in different countries

The IASB has developed international standards (IFRS)

In the past, U.S. considered its GAAP to be the strongest set of standards

In November 2008, the SEC announced it will require all U.S. public companies to adopt IFRS

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Objective

Provide information to various users that is useful for their economic decision making

Qualitative Characteristics

Understandability

Reliability

Relevance

Comparability

Constraints

Timeliness

Balance between qualitative characteristics

Benefits versus Costs

Assumptions

Accrual Accounting Stable Monetary Unit

Going Concern Economic Entity

Elements

Assets

Liabilities

Equity

Income

Expenses

Users of Accounting Information

Investors Suppliers and trade creditors

Employees

Creditors Government and its agencies

Customers

Public

Qualitative Characteristics

Understandability

Relevance

Reliability

Comparability

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Constraints

Timeliness

Balance between qualitative characteristics

Benefits versus Costs

Assumptions

Transactions and other events are recognized when they occur Entity will continue to exist indefinitely

Assumptions

Transactions of owners separate from the company. Recorded at historical cost without regard to the purchasing power of the peso
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Copyright 2011 Pearson Education South East Asia

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The Accounting Equation

ASSETS = LIABILITIES + OWNERS EQUITY

Assets
Liabilities Equity

Elements of Financial Statements

Assets

Resources that the company owns that has value and has the potential to bring economic benefit into the business. Examples are: Cash, Receivables, Inventory, Plant Assets. Claims against the assets of the business that is, existing debts and obligations of the entity. Examples are: Accounts Payable, Notes Payable, Unearned Revenue, etc. Residual claim over the assets of the business that is, the portion of assets that belongs to the owners. It is that portion of total assets after paying off the obligations of the company.

Liabilities

Owners Equity

The Accounting Equation

ASSETS = LIABILITIES + OWNERS EQUITY

Assets
Liabilities Owners Equity

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Increases and Decreases in Owners Equity

Due to Owner Transactions

INCREASE: Capital Infusion/Investment resources contributed by the owner to the business. DECREASE: Capital Drawings/Withdrawal resources taken away by the owner to the business. INCREASE: Revenue

Due to Business Operations

gross increases in owners equity resulting from business transactions entered for the purpose of earning income. It is the inflow from doing business. Cost of assets consumed or services used in the process of earning revenue. They are decreases in Owners Equity as a result of operating the business. Outflow due to doing business

DECREASE: Expenses

Increases and Decreases in Owners Equity

INCREASES

Capital Infusion/Investment assets that the owner puts into the business. Revenue gross increases in owners equity resulting from business transactions entered for the purpose of earning income.

Inflow from doing business.

DECREASES
Capital Drawings/Withdrawal assets withdrawn by owner from the business for personal use. Expenses cost of assets consumed or services used in the process of earning revenue. They are decreases in Owners Equity as a result of operating the business.

Outflow due to doing business

Expanded Accounting Equation

ASSETS = LIABILITIES + (REV + INV EXP W/DRW)

Assets
Liabilities Owners Equity
(+) Revenues Investments (-) Expenses Withdrawals

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Accounting for Business Transactions

Each transaction affects the fundamental accounting equation of A = L + OE Transaction analysis shows the effects of certain transactions on the accounting equation.

Complete Set of Financial Statements

Statement of Comprehensive Income/Profit or Loss

A report showing the financial performance of the firm. It shows the revenues, expense and net income for the period given. A report showing changes in owners equity investments, withdrawals and net incomeover a given period. A report showing the balances of Assets, liabilities and equity of the firm as of a given date.

Statement of Changes in Owners Equity

Statement of Financial Position

Complete Set of Financial Statements

Statement of Cash Flows

A report showing the summary of cash inflows and outflows of the firm. A report showing the details of the financial statement items.

Notes to Financial Statements

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Expanded Accounting Equation

ASSETS = LIABILITIES + (REV + INV EXP W/DRW)

Assets
Liabilities Owners Equity
(+) Revenues Investments (-) Expenses Withdrawals

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