Download Processing accounting information. and more Study notes Business Accounting in PDF only on Docsity!
Processing Accounting Information
Basic Accounting Concepts, Assumption and Principles
Accounting practices follow certain guidelines and rules. The rules that govern how accountants measure, process and communicate financial information are called generally accepted accounting principles (GAAP). The application of GAAP ensures that consistent accounting procedures are followed in recording the events created by business transactions and in preparing financial statements. This consistency makes it possible for internal and external users of financial statements to make reasonable judgments regarding the overall financial condition of a business and the success of business operations from period to period.
Basic Concepts and Assumptions
- Entity concept
- Going concern
- Time period
- Unit of Measurement or Monetary unit
Basic principles
- Historical costs concept
- Conservatism
- Objectivity
- Realization
- Matching
- Consistency
- Full disclosure
Basic Concepts and Assumption
1. Entity Concept
From an accounting standpoint, the business firm is treated as a separate economic entity. Thus, only the business entity’s activities and transactions should be recorded and reported. The personal activities of the owner(s) and other business entities are encountered separately, unless the activities have direct impact upon the business firm. For instance, a restaurant owner purchased a car for personal use. This will not affect the accounting records of the restaurant. However, if the delivery van is purchased by the owner with personal funds for use in the company, then this will be reflected in the records of the company.
2. Going Concern (continuity) assumption
This assumption recognizes that a firm remains in operation for the foreseeable future. The firm is expected to continue to operate long enough to meet its obligations and fulfill its plans. This assumption justifies the use of historical cost rather than current values.
3. Time Period or Periodicity assumption
This assumption recognizes that timely financial reports must be made to those who need the information in these reports. In other words, although the true financial position of a business cannot be precisely determined until its liquidation, interim financial statements are essential to making ongoing decisions during the operations of the business. Time periods of reporting can be monthly, quarterly or annually. The year is the basic time unit.
4. Monetary-unit assumption
This assumption holds that business transactions must be recorded and reported in terms of money. In the Philippines, this monetary unit is the peso. The problem with this approach is that the peso or any other currency is not a stable or constant unit of measure. Nonetheless, the peso
results of a business transaction, estimates must be made. In this case, the choice of the best estimate should be guided by the principle of objectivity.
4. Realization Principle
The principle states that the revenue resulting from business transactions should be recorded only when a sale has been made and earned. For example, when a hotel receives cash from a guest served in the dining room, a sale has been made and earned. The results of the transaction are recorded in the proper accounts. However, if the hotel receives cash for service which has not been earned then the transaction cannot be classified as a sale. For instance, if the hotel receives an advance deposit of P50,000 for a wedding reception which is to be held three months later, the cash received must be recorded, but the event is not classified as a sale but should be recorded as a liability under “Unearned Revenue” account.
5. Matching Principle
The matching principles require that, where possible, the entity’s operational efforts (expenses) be matched to the entity’s operational accomplishments (revenues). This principle states that all expenses must be recorded in the accounting period as the revenue which they helped to generate. There are two accounting methods for determining where to record the results of a business transaction: cash accounting and accrual accounting.
Cash Accounting
This method records the results of business transactions only when cash is received or paid out. Small businesses usually follow cash accounting procedures in their day-to-day bookkeeping activities. But financial statements prepared solely on a cash accounting basis may not necessarily comply with generally accepted accounting principles. The BIR generally will accept financial statements prepared on a cash accounting basis only if the business does not sell inventory products or meets other criteria. Since food and beverage operations sell inventory products, these establishments must use the accrual method.
Accrual Accounting
To conform to the matching principle, most hospitality operations use an accrual method of accounting. This method adjusts the accounting records by recording expenses which are incurred during an accounting period but which are not actually paid until the following period. Likewise, adjustment is made for revenues already earned but not yet collected.
6. Materiality
The generally accepted accounting principle of materiality states that material events must be accounted for according to accounting rules. An item or amount that would not change a user’s decision may be considered immaterial and therefore need not be recorded.
7. Consistency Principle
Consistency principle states that once an accounting method has been adopted, it should be consistently followed from period to period in order for accounting information to be comparable. Should circumstances warrant a change in the method of accounting for a specific kind of transaction, the change must be reported along with an explanation of how this change affects other items shown on the operation’s financial statement.
8. Full Disclosure Principle
This principle requires that the financial statements of a business should be complete and should report sufficient economic information relating to the business entity to make the statements understandable. Information may be on the financial statements themselves or in supplementary attachments. For example, a fire destroying significant uninsured assets of the hotel company one week after the end of the year should be reported in the Notes to Financial Statements.
creditors of the company have a claim on them (liabilities) or the owners own them free and clear (equity).
Sole Proprietorship : ASSETS = LIABILITIES + OWNER’S EQUITY Partnership : ASSETS = LIABILITIES + PARTNER’S EQUITY Corporation : ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY
Proprietorship Equity Accounts
A proprietorship requires only two accounts, namely
a) Capital, (owner’s name) b) Withdrawals, (owner’s name)
The “capital” account is an account that represents the owner’s financial interest in the business. The transactions that increase this account are:
a) Initial investment by the owner b) Additional investment c) Operating profit from the business for the accounting period.
If a net loss results, the Owner’s Capital account is decreased.
The withdrawals account is a temporary bookkeeping account used to accumulate the owner’s drawings (cash, inventory or other assets) from the business. The effect of these drawings is to reduce his or her financial interest in the proprietorship. The Financial Structure of a Proprietorship is shown in Figure 4.13.
Figure 4.13. Financial Structure of a Proprietorship
ASSETS LIABILITIES OWNER’S EQUITY
Cash and other = Claims of + Capital Items owned creditors withdrawal
Partnership Equity Accounts
Accounting for a partnership is very similar to that of a proprietorship, except that the transactions of two or more owners (partners) are involved. Therefore, each partner requires individual “capital” and “withdrawals” accounts. The partnership’s net income or loss is allocated to each partner in accordance with the partnership agreement. The financial structure of a Partnership is shown in Figure 4.14.
Partnership Equity Accounts
Accounting for a partnership is very similar to that of a proprietorship, except that the transactions of two or more owners (partners) are involved. Therefore, each partner requires individual “Capital” and “Withdrawals” accounts. The partnership’s net income or loss is allocated to each partner in accordance with the partnership agreement. The financial structure of a partnership is shown in Figure 4.14.
Figure 4.14. Financial Structure of a Partnership
ASSETS LIABILITIES PARTNERS’ EQUITY
Cash & other = Claims of + Capital, Partner A Items owned creditors Capital, Partner B Withdrawal, Partner A Withdrawal, Partner B
Analyzing Business Transactions
The account
We learned that the accounting equation is the most basic tool in accounting. It measures the assets of the business and claims to those assets. The basic summary device of accounting called the account shows the detailed record of the changes that have occurred in a particular asset, liability and owner’s (stockholders’) equity during a period of time. Accounts are grouped in three board categories, according to the accounting equation.
Assets = Liabilities + Owner’s (Stockholders’) Equity
The remainder of this chapter will be devoted to the initial step in the accounting process which is the analysis of transactions using the intuitive approach in determining the effect on the accounting equation.
To repeat: Business transactions are events that have a direct effect on the operations of an economic unit or enterprise and are expressed in terms of money. Each business transaction must be recorded in the accounting records. As on records business transactions, one has to change the amounts listed under the heading Assets, Liabilities and Owner’s Equity.
Analysis of the Effect of the Transactions of a Restaurant on the Accounting Equation.
Assume that Elmar Coffeeshop was established by Elmar Castillo on December 1, 2001 as a single proprietorship. It is located at the Festival Mall in Alabang, Muntinlupa City.
Transaction 1: Elmar invests P100,000 cash in his new business and deposits this amount in the bank in a new separate account, Elmar Coffeeshop. This separate account will help Elmar keep his business investment separate from his personal funds.
Transaction 2: Elmar buys various equipment worth P50,000 for the Coffee Shop for cash.
