175728438 TOA Summary Notes

THEORY OF ACCOUNTS SUMMARY NOTES BALIDIO, KAREN J.

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CHAPTER 1 CONCEPTUAL FRAMEWORK Definition of Accounting Accounting Standards Council (ASC) – Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about e conomic entities, that is intended to be useful in making economic decision. American Institute of Certified Public Accountants (AICPA) – 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. American Accounting Association (AAA) – Accounting is the process of identifying, measuring and communicating economic information to permit informed judgment and decision by users of the information. Three Important Activities in the Accounting Process: 1. Identifying (Analytical Component) This accounting process is the recognition or nonrecognition of business activities as “accountable” events.

 Accountable or quantifiable When it has an effect on assets, liabilities and equity (economic activity or economic resources)

2. Measuring (Technical Component) Assigning of peso amounts to the accountable economic transactions and events. It must be expressed in terms of common financial denominator.

Measurement bases are historical cost, current cost, realizable value and present value

Economic Activities referred to as transactions which may be classified as external or internal.

External Transactions (Exchange Transactions) – are those economic events involving one entity and another entity. E.g. purchase of merchandise from a supplier, borrowing money from a bank, payment of salaries to employees.

Internal Transactions –  economic events involving the entity only (take place entirely within the entity). E.g. Production and casualty loss

Recording (Journalizing) - Process of systematically maintaining a record of all economic business transactions after they have been identified and measured.

3. Communicating Preparing and distributing accounting reports to potential users of accounting information. Basic Purpose of Accounting

Implicit in the communication process are:

Classifying –  sorting or grouping of similar and interrelated economic transactions into their respective classes. It is accom lished b ostin to the led er. Summarizing – preparation of financial statements which include the statement of financial position, income statement, statement of comprehensive income, statement of cash flows and statement of changes in equity.

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To Provide quantitative financial information about a business that is useful to statement users particularly owners and creditors, in making economic decisions.

THE ACCOUNTANCY PROFESSION R.A No. 9298 – Law regulating the practice of accountancy in the Philippines. This is also known as the “Philippine Accountancy Act of 2004”.  Board of Accountancy  – is the body authorized by law to promulgate rules and regulations affecting the practice of the accountancy profession in the Philippines.  LIMITATION OF THE PRACTICE OF PUBLIC ACCOUNTANCY  Certificate of accreditation shall be issued to CPA in public practice only upon showing in accordance with rules and regulations promulgated by the BOA and approved by the PRC that such registrant has acquired a minimum of three (3) years of meaningful experience in any areas of public practice including taxation.  SEC shall not register any corporation organized for the practice of public accountancy. ACCREDITATION TO PRACTICE PUBLIC ACCOUNTANCY  PRC upon favorable recommendation of the BOA shall issue the Certificate of Registration to practice public accountancy which shall be valid for 3 years and renewable every 3 years upon payment of required fees. CPA generally practice their profession in 3 main areas: 1. Public Accounting Composed of individual practitioners, small accounting firms, and large multinational organizations that render independent and ex ert financial services to the ublic

3 kinds of Services

Taxation Service – Preparation of annual income tax returns and determination of tax consequences of certain proposed business endeavors. -CPA not infrequently represents the client in tax investigations.

2. Private Accounting Employed in business entities in various capacity as accounting staff, chief accountant, internal auditor and controller (highest accounting officer) -Major objective : assist management in planning & controlling the entity’s operations.

3. Government Accounting Encompasses the process of analyzing, classifying, summarizing and communicating all transactions involving the receipt and disposition of government funds and property and interpreting the results thereof

 Auditing (External Auditing) – has traditionally been the primary service offered by most public accounting practitioners. It is the examination of financial statements by independent CPA for the purpose of expressing an opinion as to the fairness with which FS are prepared. -The attest function of inde endent CPAs

Management Advisory Services – has no precise coverage but it is used generally to refer to services to clients on matters of accounting, finance, business policies, organizational procedures, product cost, distribution and many other phases of business conduct and operations.

Focus Custody & administration of public funds E.g. BIR, COA, SEC

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DISTINCTION BETWEEN ACCOUNTING FROM AUDITING, BOOKKEEPING AND ACCOUNTANCY ACCOUNTING Broad Sense -embraces auditing. -Auditing is one of the areas of accounting specialization. Limited Sense -It is constructive in nature. -Accounting ceases when financial statements are prepared.

AUDITING

BOOKKEEPING

ACCOUNTANCY

-It is Analytical -The work of an auditor begins when the work of the accountant ends. -Examines the FS to ascertain whether they are in conformity with Generally Accepted Accounting Principles.

-Conceptual and is concerned with the “why”, reason or justification for any action adopted.

-Procedural  & largely concerned with development and maintenance of accounting records -“How” of accounting

-used in reference only to a particular field of accountancy such as public accounting, private accounting & government accounting

-Profession of accounting practice

FINANCIAL ACCOUNTING VERSUS MANAGERIAL ACCOUNTING Financial Accounting – Primarily concerned with the recording of business transactions and the eventual preparation of financial statements.  Focuses on general purpose reports known as Financial Statements. 

Area of accounting that emphasizes reporting to creditors and investors.

Managerial Accounting – Accumulation and preparation of financial reports for internal users only.  Area of accounting that emphasizes developing accounting information for use within an entity.

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GENERALLY ACCEPTED ACCOUNTING PRINCIPLES  Rules, procedures, practice and standards followed in the preparation and presentation of financial statements. 

Conventional, meaning, they become generally accepted by agreement often tacit agreement rather than formal derivation from a set of postulates and basic concepts.

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Principles have developed on the basis of experience, reason, custom, usage, and practical necessity.

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Social Process which incorporates political actions of various user groups as well as pro fessional judgment, logic and research.

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Formalized initially through the creation of the Accounting Standards Council (ASC)

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Accounting standards promulgated by the ASC constitute GAAP.

Accounting Standards Council (ASC)

Financial Reporting Standards Council (FRSC) –replaces ASC

Approved Statement

Approved Statement

Statement of Financial Accounting

Philippine Accounting Standards

Standards (SFAS)

(PAS) and Philippine Financial Reporting Standards (PFRS)

Overall Purpose of Accounting Standards - Identify proper accounting practices for the preparation and presentation of FS. Financial Reporting Standards Council (FRSC)  Accounting standard setting body created by the Professional Regulation Commission upon the recommendation of the Board of Accountancy to assist the BOA in carrying out its powers and functions provided under R.A Act No. 9298.  Main Function: Establish and improve accounting standards that will be generally accepted in the Philippines.  Composed of 15 members with a chairman who had been or is presently a senior accounting practitioner  Term: Chairman and members shall have a term of 3 years renewable for another term.  14 representatives are from the following:

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Board of Accountancy Securities and Exchange Commission Bangko Sentral ng Pilipinas Bureau of Internal Revenue Commission on Audit Major Organization of Preparers and users of FS Accredited National Professional Organization of CPAs: Public Practice Commerce and Industry Academe or Education Government Total

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International Accounting Standards

International Accounting Standards

Committee (IASC)

Board –replaces IASC

Approved Statement

Approved Statement

International Accounting Standards

International Financial Reporting

(IAS)

Standards (IFRS)

International Accounting Standards Committee (IASC)  Independent private sector body, with the objective of achieving uniformity in the accounting principles which are used by business and other o rganizations for financial reporting around the world.  Formed in June 1973 through an agreement made by professional bodies  Headquartered in London, United Kingdom  Objective: a. To formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to Promote their worldwide acceptance and observance.

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THEORY OF ACCOUNTS BALIDIO, KAREN J. b. To work generally for the improvement and harmonization of regulations, accounting standards and procedures relating to the presentation of financial statements. Approved Statement: International Accounting Standards (IAS) Factors considered in deciding to move totally to IAS: a. Support of IAS by Philippine organizations such as SEC, BOA and PICPA b. Increasing internalization of business which has heightened interest in a common language for financial reporting. c. Improvement of IAS or removal of free choice of accounting treatments. d. Increasing recognition of IAS by World Bank, Asian Development Bank and World Trade Organization.

International Accounting Standards Board (IASB)  Replaces IASC  Publishes standards in a series of pronouncements: International Financial Reporting Standards (IFRS) IFRS – is a global phenomenon intended to bring about greater transparency and higher degree of comparability of financial reporting, both of which will benefit the investors and are essential to achieve the goal o f one uniform and globally accepted financial reporting standards.  Objective: To raise the quality and consistency of financial reporting and to have a platform of high quality and improved standards. Underlying Accounting Assumptions Going Concern

Accounting entity is viewed as

(Continuity Assumption )

continuing in operation indefinitely.

Very foundation of the “cost principle”

Basic notions or fundamental Accounting Assumptions (Postulates)

premises on

Accounting Entity

Proprietorship, Partnership or

The entity is separate from the owners, managers and employees

(Specific business Org.)

Corporation

who constitute the entity.

Time Period

The indefinite life of an entity is subdivided into

which the accounting process is based.

Calendar year – 12 month Period that ends on Dec 31.

time/accg. Periods which are usually of equal length for the purpose of preparing FS.

Monetary Unit

2 Aspects: (1) Quantifiability - Assets, Liabilities, capital, income and expenses should be stated in terms of a unit of measure which is peso .

Natural Business Year  – 12 month Period that ends in any month.

(2) Stability of the Peso  – purchasing power of peso is stable or constant that its instability is insignificant and therefore may be ignored.

Stable Peso Postulate- an amplification of the going concern assumption so much so that adjustments are unnecessary to reflect any changes in purchasing power.

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Note:

The new Conceptual Framework for Financial Reporting mentions only one assumption, namely going concern. Accrual is no longer carried forward as an underlying assumption in the new Conceptual Framework. However, implicit in accounting are the basic assumptions of accounting entity, time period and monetary unit.

Conceptual Framework  Summary of the terms and concepts that underlie the preparation and presentation of Financial Statements.  It is the underlying theory for the development of accounting standards and revision of previously issued accounting standards.  It is an attempt to provide an overall theoretical foundation for accounting which will guide standard setters, preparers and users of financial information in the preparation and presentation of statements.  Concern: General-purpose financial Statements, including Consolidated Financial Statements.  However, special purpose financial reports e.g. prospectuses and computations prepared for taxation purposes, are outside the scope of the conceptual framework.  Basic Purpose: a. Assists the FRSC in developing accounting standards that represent Philippine GAAP. b. Assists preparers of f inancial statements in applying accounting standards and in dealing with issues not yet covered by GAAP. c. Assists the FRSC in its review and adoption of IFRS/IAS. d. Assists users of financial Statements in interpreting the information contained in the financial statements. e. Assists auditors in forming an opinion as to whether financial statements conform with Philippine GAAP. f. Provide information to those interested in the work of the FRSC in the formulation of PFRS.  Authoritative Status of Conceptual Framework: - If there is a standard or an interpretation that specifically applies to a transaction, the standard or interpretation overrides the conceptual framework. - Conceptual framework is not a Philippine Financial Reporting Standards and hence does not provide for any measurement or disclosure issue. - Nothing in this framework overrides any specific Philippine Financial Reporting Standard.  Scope of Conceptual Framework: a. Objective of financial Statements b. Qualitative characteristics that determine the usefulness of information in financial Statements c. Definition, recognition and measurement of the elements from which financial statements are constructed. d. Concepts of capital and capital maintenance. Users and their Information Needs They need information about/to help them... Investors (Primary User)- Providers of risk capital and their advisers are concerned with the risk inherent in and return provided by their investment. -to determine whether they should buy, hold or sell -Shareholders  are interested in information which enables them to assess the ability of the entity to pay dividends.

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Employees  – about the stability and profitability of the entity. -to assess the ability of the entity to provide remuneration, retirement benefits and employment opportunities. Lenders (Primary User) – to determine whether their loans and interest thereon will be paid when due. Suppliers and other trade creditors (Primary User) – to determine whether amounts owing to them will be paid on maturity. Customers – about the continuance of an entity especially when they have a long term involvement with or are dependent on the entity. Governments and their Agencies – allocation of resources and therefore the activities of the entity, determine taxation policies and as a basis for national income and similar statistics. Public – FS 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.

Objective of Financial Statements  Provide information about financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. A. Financial Position (Balance Sheet) – comprises assets, liabilities and equity at a particular time. - It pertains to the economic resources, liquidity, solvency, financial structure and capacity for adaptation of an entity.    

Liquidity – availability of cash in the near future to cover currently maturing obligations. Solvency – availability of cash over a long term to meet financial commitments when they fall due. Financial Structure – Is the source of financing for the assets of the entity. It is the ratio of equity capital to liabilities. Capacity for Adaptation (Financial Flexibility) – ability of the entity to use its available cash for unexpected requirements and investment opportunities.

B. Financial Performance (Income Statement) – comprises revenue, expenses and net income or loss for a period of time. - It is the level of income earned by the entity through the efficient and effective use of its resources. - Previously known as results of operations . - Useful in predicting the capacity of the entity to generate cash flows from its operations. - Useful in forming judgment about the effectiveness of the entity in employing additional resources. C. Cash Flows  – useful in order to assess the operating, investing and financing activities of the entity during a period.

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Accounting Concepts 1. Entity Theory – Accounting objective is geared toward proper income determination. Proper matching of cost against revenue is the ultimate end. - Assets = Liabilities + Capital 2. Proprietary Theory – proper valuation of assets. Emphasizes the importance of Balance Sheet or Statement of Financial Position. - Assets – Liabilities = Capital 3. Residual Equity Theory – Proper valuation of assets. Applicable where there are two classes of shareholders, Ordinary and Preference. - Assets –  Liabilities  – Preference Shareholder’s Equity = Ordinary Shareholder’s Equity. 4. Fund Theory – Objective is neither proper income determination nor proper valuation of assets but the custody and administration of funds. E.g. Government Accounting and Fiduciary Accounting. -Fund = Cash inflows – Cash outflows Financial Reporting  Is the provision of financial information about an entity to external users that is useful to them in making economic decisions and for assessing the effectiveness of the entity’s management.  Also include nonfinancial information such as description of major products and a listing of corporate officers and directors.  Overall Objective: Provide information that is useful for decision making.  Specifically (AICPA): a. To provide information useful in investment, credit and similar decision. b. To provide information useful in assessing cash flow prospects. c. To provide information about entity resources claims to those resources and changes in them.  Limitations: a. General purpose financial reports do not and cannot provide all of the information that existing and potential investors, lenders and other creditors need. b. Not designed to show the value of the entity but they provide information to help the primary users estimate the value of the entity. c. Intended to provide common information to user and cannot accommodate every request for information. d. Based on estimate and judgment rather than exact depiction. Qualitative Characteristics  Qualities or attributes that make financial accounting information useful to the others.  Objective: ensure that the information is useful to the users in making economic decisions.

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1. Fundamental Qualitative Characteristics -Content or substance of financial information.

Qualitative Characteristics

2. Enhancing Qualitative Characteristics -Increase the usefulness of financial information.

1. Understandability 1. Relevance -Capacity of the information to make difference in a decision made by users (influence).

2. Faithful Representation -Is used instead of the term Reliability. -Actual effects of the transactions shall be properly accounted for and reported in the FS. 2. Comparability

1. Predictive Value –

2. Confirmatory Value

increase the likelihood

 – Feedback about

of correctly predicting

previous evaluations.

or forecasting outcome of events.

Materiality (Doctrine of Convenience) Item is material if knowledge of it would affect or influence the decision of the informed users of the FS. Information is material if its omission or misstatement could influence the economic decision that the users make on the basis of the financial information about the entity.

1. Relative size of the itemin relation to the total group to which the item belongs.

2. Nature of the Item – inherently material because by its nature it affects economic decision.

1. Completeness -information should facilitate understanding and avoids erroneous implication. -Result of Adequate disclosure. Standard of  Adequate Disclosureall significant and relevant information leading to the preparation of FS shall be clearly reported. Substance over Form

Conservatism

2. Neutrality -FS should not be prepared so as to favor one party to the detriment of another party.

3. Free from Error -No errors or omissions in the description of the phenomenon.

-Information in

-Process used to produce the reported information has been selected and applied with no errors in the process.

the FS must be free from bias. -“Principle of fairness”

3. Verifiability

4. Timeliness