Lesson 1

Accounting and the Business Environment

Topics:
 Definition of Accounting
 Users of Accounting Information and their needs
 Types of Business Activities
 Forms of Business Organization
 Branches of Accounting

Learning Objectives:
 Explain briefly the importance of accounting in business.
 Describe the type of information needs by each group of user.
 Differentiate the forms of business organizations as to form and activity.
 Describe the different branches of accounting and specialization.

A business refers to any organization or enterprise engaged in activities to produce and sell
goods or services to earn profit. Anywhere we go, we see business establishments ranging from
multinational companies with tall towering buildings down to a simple sari-sari store situated in
our local communities, we can visibly see that businesses surrounds us. Whether big or small
entities are, they all have one thing in common, they are all engaged in business activity with a
primary objective of earning profit. (Salosagcol, 2018)

To be able to achieve its objective of earning profit, owners need to know from time to time the
profits earned or losses sustained by the business. This information allows owners to carefully
evaluate their present operations which serves as their guide for future actions. This type of
information can be obtained in doing accounting. Accounting and business go hand in hand.
Accounting draws a concise picture of the results of operations and current financial condition of
the business. Thus, owners are relying on accounting information to be able to make sound
decisions, thereby the goals and objectives are attained. (Lopez, 2016)

Accounting shows a concise picture of the results of operations and current financial condition of
the business. It is the medium of communication between a business entity and the many parties
interested in its financial activities. (Salosagcol, 2018)

Definition of Accounting

According to the American Accounting Association, accounting is the process of identifying,

measuring and communicating economic information to permit informed judgment and decision
by users of the information.

There are three important activities included from the definition.

1. Identifying
2. Measuring
3. Communicating
 Identifying is the process of analyzing events and transactions to determine whether or not
they will be recognized in the books. Note that only accountable events are recognized in the
books.

An accountable event is an event that has an effect on the assets, liabilities or equity of an entity
and its effect can be measured reliably. This is also known as economic activity where an entity
participates. Only economic activities are recognized in accounting, psychological and
sociological activities are beyond the parlance of accounting.

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 various users.

According to the American Institute of Certified Public Accountant, 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.

From the definition, the process of communication involves four aspects:

1. Recording
2. Classifying
3. Summarizing
4. Interpreting

Recording refers to the process of systematically committing to writing accountable events

identified and measured in the books of account in a systematic and chronological manner.

Classifying refers to the process of grouping similar and related items into their respective
account.

Summarizing refers to putting together in a brief form the recorded and classified
transactions and events. This includes the preparation of the financial statements and other
accounting reports.

Interpreting is the function of accounting that involves analyzing the financial statements
and using the information obtained from the analysis to make intelligent decisions.

It is important to take note that it is not enough to only communicate the accounting information.
The accounting information should be communicated and then interpreted to users to permit
informed judgment.
The Accounting Standards Council defined accounting as 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 decision.

The overall objective of accounting is to provide quantitative financial information about a

business that is useful to statement users particularly owners and creditors in making economic
decisions.

Development of Accounting

Accounting records can be traced back to the ancient civilizations of China, Babylonia, Greece
and Egypt. Accounting was used to keep records regarding the cost of labor and materials used
in building great structures like the Pyramids. During 1400s, accounting grew further because the
needs for information of merchants in the Venice City of Italy increased. The first known
description of double entry book keeping was first published in 1994 by Lucas Pacioli. He was a
mathematician and a friend of Leonardo Ileda Vinci. The onset of the industrial revolution
necessitated the development of more sophisticated accounting system, rather than pricing the
goods based on guesses about the costs. The increase in competition and mass production of
goods led to the rise of accounting as a formal branch of study. (Ballada, 2014)

Role of Accounting in Business

Accounting is a system meant for measuring business activities, processing of information into
reports and making the findings available to decision-makers. The documents, which
communicate these findings about the performance of an organization in monetary terms, are
called financial statements. Financial statements and accounting reports tell the story of how a
company is doing financially, thus, accounting is often referred to as the language of business.

Users of Accounting Information and their needs

The accounting process provides financial data for a broad range of individuals whose objectives
in studying the data vary widely.  

Internal users are those that runs, manages and operates the daily activities within the
organization. These are persons who have access to accounting information and who can
customize the accounting information to meet their requirements.

 Owners – needs to assess how well the business is performing.

 Management – decisions concerning the running of the business and strategic planning
for the future.
 Employees – decisions on personal matters, e.g. promotion, appointments, security and
training.
External users are those individuals who take interest in the account information of an
organization but they are not part of the organization’s administrative process. These are persons
who do not have direct access to the accounting records of an organization. They rely on
information that is supplied to them by the preparers of information.

 Investors and potential investors – they need information to help them determine whether
they should buy, hold or sell. Shareholders are also interested in information which
enables them to assess the ability of the enterprise to pay dividends.
 Unions and employee groups – information on the stability, profitability and distribution
of wealth within the business.
 Lenders and financial institutions – they are interested in information which enables them
to determine whether their loans and interest thereon will be pain when due.
 Suppliers and creditors – they are interested in information which enables them to
determine whether amounts owing to them will be paid on maturity.
 Customers – information on the continued existence of the business and thus the
probability of a continued supply of products, parts and after sales service.
 Government and their agencies – they require information to regulate the activities of the
enterprise and determine taxation policies.
 Competitors – information on the relative strengths and weaknesses of their competition
and for comparative and benchmarking purposes. Whereas the above categories of users
share in the wealth of the company, competitors require the information mainly for
strategic purposes.
 The public – information on the role and contribution of businesses to society.

Types of business

A business entity is an organization that uses economic resources to provide goods or services to
customers in exchange for money or other goods and services. Business organizations come in
different types and in different forms of ownership.

There are three major types of businesses:

1. Service Business
2. Merchandising Business
3. Manufacturing Business

Service Business - A service type of business provides intangible products (products with no

physical form). Service type firms offer professional skills, expertise, advice, and other similar
products.

Examples of service businesses are: salons, repair shops, schools, banks, accounting firms, and
law firms.

Merchandising Business - This type of business buys products at wholesale price and sells the
same at retail price. They are known as "buy and sell" businesses. They make profit by selling
the products at prices higher than their purchase costs. A merchandising business sells a product
without changing its form.

Examples are: grocery stores, convenience stores, distributors, and other resellers.

Manufacturing Business - Unlike a merchandising business, a manufacturing business buys

products with the intention of using them as materials in making a new product. Thus, there is a
transformation of the products purchased. A manufacturing business combines raw materials,
labor, and overhead costs in its production process. The manufactured goods will then be sold to
customers.

Hybrid Business - are companies that may be classified in more than one type of business. A
restaurant, for example, combines ingredients in making a fine meal (manufacturing), sells a cold
bottle of wine (merchandising), and fills customer orders (service).

Forms of Business Organization

These are the basic forms of business organizations:

Sole Proprietorship - A sole proprietorship is a business owned by only one person. It is easy to
set-up and is the least costly among all forms of ownership. The owner faces unlimited liability;
meaning, the creditors of the business may go after the personal assets of the owner if the
business cannot pay them. The sole proprietorship form is usually adopted by small business
entities.

Partnership - A partnership is a business owned by two or more persons who contribute

resources into the entity. The partners divide the profits of the business among themselves.

Corporation - A corporation is a business organization that has a separate legal personality from
its owners. Ownership in a stock corporation is represented by shares of stock. The owners
(stockholders) enjoy limited liability but have limited involvement in the company's operations.
The board of directors, an elected group from the stockholders, controls the activities of the
corporation.

Cooperative - A cooperative is a business organization owned by a group of individuals and is

operated for their mutual benefit. The persons making up the group are called members.
Cooperatives may be incorporated or unincorporated. Some examples of cooperatives are: water
and electricity (utility) cooperatives, cooperative banking, credit unions, and housing
cooperatives.
 Sole
Partnership Corporation Cooperative
Proprietorship
Number of
One Two or More Five or more Fifteen or more
Owners
Owners' Stockholder or
Proprietor Partners Members
Designation Shareholder
By the will of By the agreement By operation of
Creation By operation of law
the owner among partners law
Limited to the Limited to the
Owners' Liability Unlimited Unlimited extent of extent of
for losses liability Liability stockholders' members'
contribution only contribution only
Cooperatives and
Partner is taxed Generally, both the Both the
share of members
and not the Partnership and the Corporation and
from the profit of
Tax Liability business partners are taxed Stockholders are
cooperative
resulting in resulting in higher taxed resulting in
generally are not
lower taxes taxes higher taxes
taxable

MAJOR AREAS OF ACCOUNTING

Financial Accounting – focuses on the development and communication of financial information

for external users.

Management Accounting – is concerned primarily with financial reporting for internal users.
Internal users, especially management, have control over the accounting system and can specify
precisely what information is needed and how the information is to be reported.

Tax Accounting – is concerned with the type of information that will assist business entities in
complying with tax laws and regulations

Government Accounting – deals with the recording and reporting of government agencies. It is a
branch of accounting that aims to produce transparent financial information about the allocation
and utilization of government funds.
Review Questions

1. Why is accounting often referred to as the language of business?

2. Why do various users need accounting information?
3. What are the different forms of business organization? Discuss each briefly.
4. What are the different types of business? Differentiate one from another briefly.

Name: Score:
Block: Date:

Exercise 1. Multiple Choice. Read and analyze each items carefully. Write the letter of your
which corresponds to your choice on the space before the number.

1. What is the correct sequence of the accounting process?

a. Identification, Communication, Recording
b. Recording, Communication, Identification
c. Identification, Recording, Communication
d. Communication, Recording, Identification

2. Accounting is called the language of business because of its main function of

a. Communicating
b. Identifying
c. Processing
d. Recording

3. Accounting information is communicated to interested users through

a. Government agencies
b. Financial Statements
c. Accounting Journals
d. Accounting Ledgers

4. Internal users of accounting information include all of the following, except

a. Company Officers
b. Creditors
c. Marketing Managers
d. Production Supervisors

5. Which of the following is not considered as an internal user of accounting information?

 a. The president of a company.
b. The sales manager of a company.
c. The members of the board of directors of a company.
d. The prospective investors of a company.

6. Which of the following corresponds to a sole-proprietorship form of business

organization?
a. It must have at least two owners.
b. The owner is personally liable for business debts.
c. It had an indefinite life.
d. It is created by operation of law.

7. The owners of a corporation are called

a. Proprietor
b. Partners
c. Members
d. Stockholders

8. A merchandising type of business buys goods and

a. Uses them in providing services to customers.
b. Uses them as an input to produce another product.
c. Sells them in the same form.
d. Sells them at a lower price.
9. Which among the following is an advantage of a cooperative form of business
organization?
a. It is not subject to income tax.
b. Its members manage the business.
c. It can transact business with anyone.
d. It is easy to form.

10. It is primarily concerned with the type of information needed by the management.
a. Education Accounting
b. Financial Accounting
c. Government Accounting
d. Management accounting
Name: Score:
Block: Date:

Exercise 2. Identification. Below are examples of business entities. Identify the type of activities
these entities are engaged in, whether it is Service, Merchandising or Manufacturing.

1 Grocery Store
2 Barber Shop
3 Hotel
4 Electric Distribution Company
5 Cement Factory
6 Appliance Store
7 Schools
8 Drug Store
9 Television Network Company
10 Textile Factory
References:

Ballada, S. and Ballada,, W. (2014). Accounting Fundamentals. Manila: DomDane Publishers.

Lopez, R. M. Jr. (2016). Fundamentals of Accounting. Davao City: MS Lopez Printing and
Publishing.

Salosagcol, J (2018). Accounting. Manila: Re Leone Publishing.