CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS

BULLET REVIEW

Topic #1: Overview of Accounting

DEFINITIONS OF ACCOUNTING
Accounting was defined in various ways by various organizations.
- 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. (Accounting Standards
Council)
- an information system that measures, processes and communicates financial information about an
economic entity. (Financial Accounting Standards Board)
- process of identifying, measuring and communicating economic information to permit informed
judgements and decisions by users of the information. (American Accounting Association)
- 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 Institute of Certified Public Accountants)

The definition that has stood the test of time is the definition given by the American Accounting Association because
it stated the three (3) important activities/aspects/components of the accounting process.

Accounting Cycle refers to a series of sequential steps/procedures performed to accomplish the accounting process.

Step 1 Identification of events to be recorded

Aim: to gather information about transactions/events generally through the source documents.
Step 2 Transactions are recorded in the journal
Aim: to record the economic impact of transactions on the firm in a journal which is a form that
facilitates transfer to the accounts.
Step 3 Journal entries are posted to the ledger
Aim: to transfer the information from the journal to the ledger for classification.
Step 4 Preparation of a Trial Balance
Aim: to provide a listing to verify the equality of debits and credits in the ledger.
Step 5 Preparation of the worksheet including adjusting entries
Aim: to aid in the preparation of Financial Statements.
Step 6 Preparation of the Financial Statements
Aim: to provide useful information to decision makers.
Step 7 Adjusting journal entries are journalized and posted
Aim: to record the accruals, expiration of deferrals, estimations and other events from the
worksheet.
Step 8 Closing journal entries are journalized and posted
Aim: to close temporary accounts and transfer profit to owner’s equity.
Step 9 Preparation of a Post-closing Trial Balance
Aim: to check the equality of debits and credits after the closing entries.
Step 10 Reversing journal entries are journalized and posted
Aim: to simplify the recording of certain regular transactions in the next accounting period.

Three (3) important activities/aspects/components in the definition of accounting:

Identifying is the process of analyzing events and transactions to determine whether/not they will be recognized.
Measuring involves assigning numbers, normally in monetary terms, to the economic transactions and events.
Communicating is the process of transforming economic data into useful accounting information, such as financial
statements and other accounting reports, for dissemination to users. It also involves interpreting the significance of
the processed information.
Recognition refers to the process of including the effects of an accountable event in the statement of financial
position or the statement of comprehensive income through a journal entry.

Accountable event/economic activity is one that affects the assets, liabilities, equity, income/expenses of an entity.

Types of events/transactions:
External events are events that involve an entity and another external party.
Exchange/Reciprocal transfer (sale, purchase, payment of liabilities)
Non-reciprocal transfer (donations, gifts/charitable contributions)
Other than transfer (changes in fair values and price levels, obsolescence)
Internal events are events that do not involve an external party.
Production (conversion of raw materials into finished goods, production of farm products)
Casualty (loss from fire, flood and other catastrophes)

BASIC PURPOSE OF ACCOUNTING

To provide information that is useful in making economic decisions.

Types of information provided by accounting:

Quantitative information is information expressed in numbers, quantities/units.
Qualitative information is information expressed in words/descriptive form.
Financial information is information expressed in money.

Types of accounting information classified as to users’ needs:

General purpose financial information is designed to meet the common needs of most statement users. This is
provided under financial accounting. This is governed by generally accepted accounting principles (GAAP)
represented by Philippine Financial Reporting Standards.
Special purpose financial information is designed to meet the specific needs of particular statement users. This is
provided by other types of accounting other than financial accounting.

DEFINITION OF ACCOUNTING CONCEPTS

Accounting concepts refer to the principles upon which the process of accounting is based.

Examples of accounting concepts:

Double-entry system – each accountable event is recorded in two parts (debit and credit)
Going concern assumption – entity is assumed to carry on its operations for an indefinite period of time.
Entity concept – entity is viewed separately from its owners.
Stable monetary unit – the Philippine peso is a reasonable unit of measure and that its purchasing power is relatively
stable.
Periodicity concept – life of the entity is divided into series of reporting periods. It allows the users to obtain timely
information to serve as a basis on making decisions about future activities.
Materiality concept – financial reporting is only concerned with information that is significant enough to affect
evaluations and decisions. Information is material if its omission/misstatement could influence economic decisions.
It is a matter of professional judgement and is based on the size and nature of the item being judged.
Cost-benefit – cost of processing and communicating information should not exceed the benefits to be derived from
it.
Accrual basis – effects of transactions and other events are recognized when they occur and they are recorded in the
accounting records and reported in the financial statements of the period to which they relate.
Historical cost concept – value of an asset is determined on the basis of acquisition cost.
Concept of Articulation – all the components of a complete set of financial statements are interrelated.
Full disclosure principle – nature and amount of information included in the financial statements reflect a series of
judgmental tradeoffs. All relevant information that would affect the user’s understanding and assessment of the
accounting entity be disclosed in the financial statements.
Consistency concept – financial statements are prepared on the basis of accounting principles that are applied
consistently from one period to the next to achieve comparability over time.
Matching – costs are recognized as expenses when the related revenue is recognized.
Entity theory – geared towards proper income determination. “Assets = Liabilities + Capital”
Proprietary theory – geared towards proper valuation of assets. “Assets – Liabilities = Capital”
Residual equity theory – applicable when there are two classes of shares issued. This is applied in the computation
of book value per share and return on equity. “Assets – Liabilities – Preference Shareholders’ Equity = Ordinary
Shareholders’ Equity”
Fund theory – custody and administration of funds. “Cash inflows – Cash outflows = Fund”
Realization – process of converting noncash assets into cash/claims for cash.
Prudence/ Conservatism – use of caution when making estimates under conditions of uncertainty. Assets/Income
are not overstated and Liabilities/Expenses are not understated.
Objectivity principle – accounting records and statements are based on the most reliable data available so that they
will be as accurate and useful as possible. Accounting records are based on information that flows from activities
documented by objective evidence.
Revenue recognition principle – revenue is recognized in the accounting period when goods are delivered/services
are rendered/performed.
Expense recognition principle – expenses should be recognized in the accounting period in which goods and services
are used up to produce revenue and not when the entity pays for the goods and services.
a. Direct association of costs and revenues – costs that are directly related to the earning of revenue are
recognized as expenses in the same period the related revenue is recognized. (cost of sales, freight out
sales commissions)
b. Systematic and rational allocation – costs that are not directly related to the earning of revenue are
initially recognized as assets and recognized as expenses over the periods their economic benefits are
consumed, using some method of allocation. (depreciation, amortization, expensing of prepayments,
effective interest method)
c. Immediate recognition – costs that do not meet the definition of an asset/ceases to meet the definition
of an asset are expensed immediately. (casualty losses, impairment losses)

BRANCHES OF ACCOUNTING
Financial accounting – focuses on general purpose financial statements.
Management accounting – accumulation and communication of information for use by internal users or
management.
Cost accounting – systematic recording and analysis of the costs of materials, labor and overhead incident to
production.
Auditing – process of evaluating the correspondence of certain assertions with established criteria and expressing an
opinion thereon.
Tax accounting – preparation of tax returns and rendering of tax advice.
Government accounting – placing emphasis on the custody of public funds, the purposes for which those funds are
committed and the responsibility and accountability of the individuals entrusted with those funds.
Fiduciary accounting – handling of accounts managed by a person entrusted with the custody and management of
property for the benefit of another.
Estate accounting – handling of accounts for fiduciaries who wind up the affairs of a deceased person.
Social accounting – process of communicating the social and environmental effects of an entity’s economic actions
to the society.
Institutional accounting – accounting for non-profit entities other than the government.
Accounting systems – installation of accounting procedures for the accumulation of financial data and designing of
accounting forms to be used in data gathering.
Accounting research – careful analysis of economic events and other variables to understand their impact on
decisions.
THE ACCOUNTANCY PROFESSION
Accountancy refers to the profession/practice of accounting.
Public practice does not involve an employer-employee relationship.
Private practice involves an employer-employee relationship.

RA 9298 “Philippine Accountancy Act of 2004”

Practice of Public Accountancy involves the rendering of audit/accounting related services to more than one client
on a fee basis.
Practice in Commerce and Industry refers to employment in the private sector in a position which involves decision
making requiring professional knowledge in the science of accounting and such position requires that the holder
must be a CPA.
Practice in Education/Academe refers to employment in an educational institution which involves teaching of
accounting, auditing, management advisory services, finance, business law, taxation and other technical related
subjects.
Practice in the Government – employment/appointment to a position in an accounting professional group in the
government/in a GOCC, including those performing proprietary functions, where decision making requires
professional knowledge in the science of accounting/where civil service eligibility as a CPA is a prerequisite.

DEFINITION OF ACCOUNTING STANDARDS

Accounting Standards are authoritative statements of how particular types of transaction and other events should
be reflected in the financial statements. Accordingly, compliance with accounting standards will normally be
necessary for the fair presentation of financial statements.

The current standard setting body in the Philippines is the Financial Reporting Standards Council (FRSC) while the
current standard setting body internationally is the International Accounting Standards Board (IASB).

Philippine Financial Reporting Standards (PFRS) represent the GAAP in the Philippines. They are standards and
interpretations adopted by the FRSC. They comprise of PFRS, PAS and interpretations.

Hierarchy of Reporting Standards

1. Philippine Financial Reporting Standards (PFRS)
2. In the absence of a PFRS that specifically applies to a transaction/event, management shall use its
judgement in developing and applying an accounting policy that results in information that is relevant and
reliable.
Management shall (must/required) refer to and consider the applicability of the following:
a. requirements in PFRS dealing with similar and related issues
b. Conceptual Framework
Management may (optional) also consider the following:
a. Pronouncements of other standard-setting bodies
b. Accounting literature and accepted industry practices