TABLE OF CONTENTS

BASIC ACCOUNTING 4 TH EDITION

CHAPTERS PAGE
Chapter 1: Introduction to Accounting 01
History of Accounting 01
The Cradle of Civilization 01
Evolvement of Double-Entry System 02
Subsequent Developments 04
Florentine vs. Venetian Approach to Reporting 05
Savary Commercial Code (Historical Cost Method of Accounting) 06
Napoleonic Commercial Code (Fair Value Method of Accounting) 06
Schmalenbach and the Chart of Accounts 06
Savary, Napoleonic, Schmalenbach Valuation 07
The Industrial Revolution and the Share-Issuing Company 08
The Arrival of Income Taxation and the Conflict with Financial Accounting 08
The Rise of the Group of Companies and the Need for Consolidated Accounts 09
Internationalization of Markets and Reporting 10
Benefits of Global Accounting Standards 11
Accounting Variations Among Countries 11
Linkage of Tax Laws and Accounting Principles Requirements 13
Degree of Development of the Capital Markets 13
Harmonization of Accounting Standards 14
The Financial Reporting Standards Council (FRSC) 15
Philippine Regulatory Agencies 16
Professional Organizations of CPAs 16
Chapter 1 Review Questions 18
Chapter 2 Problems 19

Chapter 2: The Accounting Profession 29

Definitions of Accounting 29
Nature of Accounting 31
Functions of Accounting 33
Purpose of Accounting 35
Objectives of Accounting 35
Scope of Accounting 37
Users of Accounting Information 37
Bookkeeping, Accounting, and Auditing 40
The Classical Notion of Accounting Stewardship 40
Specialized Fields or Branches of Accounting 41
 Public Accounting 41
Private Accounting 42
Government Accounting 44
Accounting Education 44
The Profession of Accountancy 45
Professions Common Characteristics 46
Basic Professional Values and Ethics 47
Career Opportunities in Accounting Profession 50
Business Organizations Served by Accountants 52
Primary Activities of Businesses 53
The Accountant of the 21st Century 54
The Stairway of a Certified Public Accountant 55
Chapter 2 Review Questions 56
Chapter 2 Problems 57

Chapter 3: Accounting Concepts and Principles 71

Accounting Concepts, Conventions, and Principles 71
The Generally Accepted Accounting Principles 72
Conceptual Framework of Financial Reporting 72
Overview of Conceptual Framework 73
Basic Assumptions in Accounting 74
Economic Entity Assumption 74
Going Concern Assumption 74
Monetary Unit Assumption 75
Periodicity Assumption 75
Accrual-Basis Assumption 78
Basic Principles of Accounting 78
Measurement Principles 78
Revenue Recognition Principle 79
Expense Recognition Principle 80
Full-Disclosure Principle 81
Accounting Constraints 82
Cost Constraint 82
Materiality Constraints 82
Limitations of Accounting Concepts 83
Qualitative Characteristics of Accounting Information 83
Hierarchy of Accounting Qualities 84
Fundamental Qualities of Accounting 84
Relevance 84
Faithful Representation 85
Enhancing Qualities of Accounting 86
Basic Financial Statements 87
Elements of Financial Statements 89
Relationships among The Financial Statements 90
Comparison of Financial Statements 91
Statement of Comprehensive Income (SCI) 91
Statement of Owners Equity (SOE) 91
Statement of Financial Position 92
Statement of Cash Flows 93
Management Role in FS Preparation 94
Limitations of Financial Statements 94
Definitions, Classifications and Example of Accounts 94
Real Accounts 94
The Asset Accounts 95
The Liability Accounts 97
The Owners Equity Accounts 98
Nominal Accounts 98
The Revenue Accounts 98
The Expense Accounts 99
Chapter 3 Review Questions 100
Chapter 3 Problems 101

Chapter 4: Accounting Information System 121

Introduction to Accounting Information System 121
Accounting Information System (AIS) 122
Purpose or Functions of AIS 123
Stages of Accounting Information System 123
Features of Effective AIS 124
Coverage of AIS 125
Basic Elements of AIS 125
Methods and Processing of Accounting Information 126
Comparison of Computerized and Manual Accounting Systems 127
Advantages and Disadvantages of Computerized and Manual Accounting Systems 128
Business Transactions and Events 128
External and Internal Business Transactions 129
Source Documents 129
The Double-Entry System vs. Single-Entry System 134
The Accounts and the Book of Accounts 135
The T-Account 135
The Chart of Accounts 136
Classification of Journal Books 138
Steps in Journalizing a Transaction 139
The Ledgers 139
Posting to the Ledger 142
Steps in Posting from the Journal to the Ledger 143
The Trial Balance 144
Footing the General Ledger Accounts (Manual Accounting) 144
Open and Closed Accounts 145
Steps in Preparing the Trial Balance (Manual Accounting) 145
Trial Balance with Equal Sides 146
Trial Balance Out-of-Balance 146
Hints for Locating Errors 147
The Accounting Worksheet (Working Papers) 149
Procedures in the Preparation of Worksheet 149
Flows of Accounting Activities 150
Summary of Accounting Process 153
Chapter 4 Review Questions 154
Chapter 4 Problems 155

Chapter 5: Analyzing and Summarizing Business Transactions 175

The Normal Balance of Accounts 175
The Rules of Debit and Credit 175
Summary of Debit and Credit Analysis 180
The Basic Accounting Equation 180
The Expanded Accounting Equation 182
Working Capital 182
Cash Receipts and Disbursements 183
Business Transactions and the Accounting Equation 183
Owners Drawing Accounting vs. the Owners Capital Account 185
Analyzing and Accounting for Business Transactions 185
Business Activities 196
Financing Activities 197
Investing Activities 198
Operating Activities 199
Preparation of Financial Statements 202
Relationships of Financial Statements 203
Chapter 5 Review Questions 204
Chapter 5 Problems 205

Chapter 6: Recording Business Transactions 237

The Recording Process (Journalizing and Posting) 237
Recording Process Flowchart 238
Recording in Two-Column Journal 238
Forms of Journal Entries 239
Recording of Transactions of Service Business 240
Recording Initial Investment 241
 Recording Changes in Assets 241
Recording Changes in Liabilities 242
Recording Changes in Capital 243
Recording Changes in Income and Expenses 244
Recording Withdrawals of Owner 244
Posting to the Ledgers 245
Importance of Posting Reference 246
Completing the Trial Balance 251
Preparation of Financial Statements 252
Use of Accounting Information for Decision-Making 253
Recording Other Transactions 254
Recording Bank Loans 255
Recording Promissory Notes 255
Interest Bearing Notes Payable 256
Non-Interest Bearing Notes Payable 256
Recording Discounting of Notes Receivable 257
Recording Discounting of Notes Payable 258
Recording Acquisition of Property and Equipment 260
Recording Sale of Property and Equipment 262
Recording Credit Note (Memo) Issued to Customer 262
Recording Debit Note (Memo) Received from Supplier 263
Recording Value-Added Tax (VAT) 264
Recording Income Taxes 265
Chapter 6 Review Questions 266
Chapter 6 Problems 267

Chapter 7: Measuring Business Income 289

Measuring Business Income 289
Comparison of Accrual and Cash Basis Accounting 290
Overview of Adjusting Process 291
Basic Adjusting Process 292
Accruals 292
Accrued Revenue 292
Accrued Expense 293
Prepayments 294
Asset Method of Recording Prepayments 295
Expense Method of Recording Prepayments 295
Pre-collections 298
Liability Method of Recording Pre-collection 298
Revenue Method of Recording Pre-collection 298
Depreciation 301
Amortization 303
 Estimated Uncollectible Accounts 305
Recovery of Accounts Previously Written Off 307
Methods of Estimating Doubtful Accounts 308
Percent of Sales 308
Percent of Accounts Receivable 309
Aging of Accounts Receivable 310
Debit Balance of Allowance for Doubtful Accounts 312
Ending Inventory 314
Bank Account Reconciliation 316
Journalizing Adjusting Entries 318
Posting of Adjustments 320
Preparation of Adjusted Trial Balance 322
Preparation of the Financial Statements 323
Managements Role in the Financial Statement Preparation 324
Chapter 7 Review Questions 325
Chapter 7 Problems 326

Chapter 8: Completing the Accounting Cycle 351

The Accounting cycle 351
The Basic Accounting Cycle 352
Financial Statements from the Worksheet 359
Journalizing and Posting Adjusting Entries 360
Journalizing and Closing Entries 360
Nature of Closing Entries 360
The Income Summary Account 360
Procedures in Closing the Account 361
Closing the Beginning Inventory Account (Periodic Inventory) 362
Closing Entries of the Nominal Accounts 363
Posting the Closing Entries 364
Reversing Entries 365
Rules in Reversing Journal Entries 366
Chapter 8 Review Question 367
Chapter 8 Problems 368

Chapter 9: Correcting Entries 385

Nature of Correcting Entries 385
Classification of Accounting Errors as to Nature or Form 385
Discovery of Errors and their Appropriate Corrections 390
Error Discovered at the Time of Journal Entry 391
Error Discovered after Posing 392
 Error Discovered After the Adjusting Entries 392
Error Discovered After Closing Nominal Accounts 393
Error Discovered After Closing the Income Summary 394
Summary of Correcting Entries 395
Nominal Accounts Still Open 396
Nominal Accounts Temporarily Closed 396
Prior Period Corrections 397
Summary of Accounting Errors as to Account Affected 397
Perpetual vs. Counter - Balancing Errors 397
Perpetual Accounting Errors 398
Counter- Balancing Errors 398
Analysis of Counter Balancing Errors 398
Chapter9 Review Questions 400
Chapter9 Problem 401

Chapter 10: Accounting for Servicing Business 421

Nature of a Service Business 421
Accounting for income 421
Conventional Approach 422
Nonconventional Approach 425
Chapter 10 Review Questions 432
Chapter 10 Problems 433

Chapter 11: Accounting for Merchandising Business 453

Nature of a Merchandising Business 453
Operating Cycle of Servicing and Merchandising Business Compared 454
Comparison of Statements of Comprehensive Income 454
Nominal Accounts of Merchandising Business 455
Major Business Activities of a Merchandising Firm 456
Trade Discounts 457
Cash Discounts 457
Cash Discounts on Partial Collection 462
Cash Discounts Not Taken 465
Effects of Discounts to VAT 465
Gross Method vs. Net Method of Recording Cash Discounts 467
Cost of Transportation 468
F.O.B., Shipping Point vs. F.O.B., Point of Destination 470
Freight Prepaid vs. Freight Collect 470
Inventory Accounting System 472
Periodic Inventory System 473
Perpetual Inventory System 474
Comparative Entries Periodic and Perpetual Systems 476
 Determination of Merchandise Inventory, Cost of Goods Sold and Gross Margin 479
Perpetual Inventory Systems Cost Methods 479
Periodic Inventory Systems Cost Methods 480
Inventory Valuation 480
Adjusting and Closing Entries 483
Working Paper of Merchandising Business 484
Financial Statements of Merchandising Business 486
Adjusting Entries of Merchandising Business 487
Closing Entries of Merchandising Business 488
Post Closing Trial Balance of Merchandising Business 491
Chapter 11 Review Questions 496
Chapter 11 Problems 497

Chapter 12: Accounting for Manufacturing Business 521

Nature of a Manufacturing Business 521
Chart of Accounts of Manufacturing Business 522
Operating Cycle of Manufacturing Business 523
Cost Elements of Manufacturing Business 523
Comparative Cost Flow 524
Prime Cost and Conversion Cost 525
The Cost of Goods Manufactured and Sold 525
Cost versus Non Cost System 526
Transactions Related to Manufacturing Process 528
Accounting for Materials 528
Accounting for Labor 529
Accounting for Factory Overhead 529
Comprehensive Application (Non Cost System) 531
Cost Accumulation Procedures 539
Distinction of Process Costing and Job Order Costing 539
Process Costing 540
Job Order Costing 542
Just in Time (JIT) Accounting 543
Activity Based Costing (ABC) System 545
Chapter 12 Review Questions 547
Chapter 12 Problems 548

Chapter 13: Taxes and Payroll Accounting 573

Tax Accounting 573
Accounting for Taxes 573
Percentage Tax and Income Tax 574
Value Added Tax and Income Tax 575
Value Added Tax versus Percentage Tax (R.A. 9337) 577
 Payroll Accounting 578
Employees Pay 578
Overtime Pay 578
Holiday Pay 579
Deduction from Gross Pay 580
Withholding Income Tax 580
PHILHEALTH Contributions 582
SOCIAL SECURITY SYSTEM Contributions 583
PAG IBIG Fund Contributions 583
Accounting for Fringe Benefit Tax 588
Chapter 13 Review Questions 589
Chapter 13 Problems 590

Chapter 14: Special Journals 601

The Special Journals 601
Relationship of Special Journals and General Journal 602
Purchases on Account Journal 602
Cash Payments Journal 605
Sales on Account Journal 607
Cash Receipts Journal 610
Chapter 14 Review Question 612
Chapter 14 Problems 613

Practice Set Wagwag Clothes 625

Glossary 669
Revised Syllabus (CHED Memo No. 3, Series 2007) 679
Bibliography 683
 INTRODUCTION TO
ACCOUNTING
Chapter Outline
1. History of Accounting
2. Accounting Variations among Countries
3. Harmonization of Accounting Standards

HISTORY OF ACCOUNTING
Accounting, as a language of business, is as old as civilization. It has evolved in
response to economic and social needs of men. It started with a simple recording of
repetitive exchanges.

As the business accumulated wealth and resources, record-keeping and

documents were used as proofs of transaction and events. These records of transactions
and events were used not only as evidences but also as tools to track the repetitious and
voluminous business transactions, to conduct inventory and evaluate the progress of
business.

Accounting played a vital role when money, banking and credit were invented.
These were important components in the rise of great civilizations of the ancient world.

The Cradle of Civilization. Around 3600 BC, record- Take a dream. Mix it with
keeping was already common from Mesopotamia, China, motivation plus action.
and India to Central and South America. The oldest Add long hours of practice
plus discipline.
evidence of this practice was the clay tablet of
Mesopotamia, 90% of which dealt with commercial Yield: Your goal, whatever
transactions, accounts, payable, and receivables. Tithes to it may be.
ruling theocratic class were faithfully recorded in many Dennis Waitley
occasions as to both quantity and value.
Simple accounting is mentioned in the New Testament. For example, Matthew 25:19
states, After a long time, the lord of those servants came to settle accounts with them.
The Quran also mentioned simple accounting for trade and credit arrangements. (Sura 2
Al Baqarah: 282)

Some of the oldest written accounting records,

dating to 2100 B.C., are drawing attention to the
Library and could be included in a new book.
Researchers have translated the ancient writing
on the tablets, which were found to contain
records of tax assessments and payments.

Evolvement of Double-Entry System. The early history of double-entry bookkeeping

cannot be traced with much accuracy. The earliest known examples of this technique
are the mercantile books of Frenis Bonis of Montauban, dated 1339.

However, the evolution of double-entry accounting system has an Italian influence in

the 13th to 15th century.

In Genoa, the oldest double-entry books entitled Massari (Treasury Officials)

Ledgers of Commune of Genoa were written in 1340. These books were known
as a perfect double-entry form because separate pages were used for debit and
credit.
Under the present system, this is simplified into the T-Account and expanded into the
Ledger.

Example of T-Account

Cash
Debit Credit
1/1 20, 000 1/5 10, 000
1/8 15, 000 1/12 3, 000

Example of a ledger

GENERAL LEDGER
Account: Accounts Receivable Account no: 120
Date Item PR Dr. Date Item PR Cr.
200x 200x
1/1 Begi nning balance 50, 000 1/15 Col l ecti ons GJ-02 100,000
1/2 Sa l es on a ccount GJ-01 200, 000
 In Florence, there were double-entry records wherein debts were written over credits. It
is also in Florence that manuscripts of Partnership and Association Contracts
reflecting how partners capital, division of profit and losses, and dissolution of
partnership were computed.
In the present system, the Florentine Method is observed in the Journal Entries with double-
entry bookkeeping.
Double-Entry Bookkeeping. The double-entry bookkeeping system is based on the dual aspect concept
which says that in every business transaction, two effects of recording are to be made the value received
(debit) and the value parted with (credit).

The basic principle of bookkeeping is the principle of balance. It is a principle that distinguishes double
entry bookkeeping from mere record keeping.

Double entry means that at least two entries are made in recording each transaction operation. This
system causes on entry to balance with the other ad thereby provides a means of proof. If each
transaction is so recorded that one entry may be checked against another entry for the purpose of proof,
and then the aggregate of all entries may be proven.

An example of double entry bookkeeping is as follows:

General Journal
The Date Descriptions PR Page Number 01
200x Debit Credit
01/13 Ca s h 200,000
Cruz, Ca pi ta l 200,000
To record i ni tia l i nves tment of the owner

transaction regarding the initial investment of the owner is recorded twice in the general journal one is
Cash (debit side) which represents the value received by the business, and the other is Capital (credit side),
the corresponding reciprocal value parted with or the obligation of the business to hold in trust the
investment of the owner.

Venice of Northern Italy had key influence in the use of the double-entry system in
1400s.
In 1494, Luca Pacioli (1447-1517), an Italian monk and mathematician, wrote Summa de
Arithmetica, the first book that was published containing a detailed chapter of double-
entry bookkeeping which enabled others to study and use it.

In this book, Pacioli introduced three important books of records, namely:

a. Memorandum Book for all information on a transaction;

b. Journal Book for the original entry; and
c. Ledger Book for the final entry (posting, the center of accounting system).
Through the Venetian Method, the double-entry accounting became known to the
world and became the standard not only for the Italians but also for the Dutch, German,
and English authors of accounting books. The present Ledger Posting is the modern
adaption of the Venetia Method.

For this reason, Luca Pacioli is known as the Father of Modern Accounting even if he
was neither an accountant nor a merchant.

Subsequent Developments

French Revolution (1700s). The thorough study of accounting and development of

accounting theory began in this period. Social upheaval affecting government,
finances, laws, customs, and business, had greatly influenced this development.
Industrial Revolution (1760 1830). Mass production and great importance of
fixed assets were given attention during this period.
Global Industrial Economy (1900s). This resulted in rapid changes to accounting
practice and reporting, and participative promulgation of accounting standards.
Notable accounting practices were developed such as (1) mergers, acquisitions
and growth of multinational corporations, and (2) internal and external reporting
and control systems.
International Business Transactions and International Relationships of Government
(2000s). To facilitate accounting work, the development of computer-assisted
accounting practice and reporting developed rapidly and dominant to date.

With the globalization of business and diverse accounting practice, efforts have been
made to harmonize international accounting and reporting standards across countries.
Chapter 1: Introduction to Accounting

Summary: The 10, 000 years of accounting history started with simple stone tokens or
clay tablets system to count wealth. With the rapid growth of industrialization,
mergers and consolidations, and globalization of businesses, accounting dynamically
developed from manual to electronically assisted information system including the
integration of computer systems and the internet as of today.

Florentine vs. Venetian Approach to Reporting

In the 14th century, Amatino Manucci, the inventor of double-entry bookkeeping and a
partner of a merchant partnership called Giovanni Farolfe & Company in Florence,
introduced the Florentine Approach (this method is now shown in the journal entries.)

This method records each transaction resulting in at least one account being debited
and at least one account being credited, with the total debits of the transaction equal to
the total credits. The financial records that Manucci kept for the firm are the oldest
extant examples of the double-entry system.

The Venetian Approach (now, our ledger postings) of double-entry system is perhaps
the mos famous. Merchants kept their accounts in bilateral form (alla veneziana), with
debits recorded on the left side of the page across form credit. They point to a highly
evolved system using several books, carefully cross-indexed and coordinated to form a
coherent whole.

The Venetian Method was introduced in the extent books of the

merchant Andrea Bargarigo (1418-1449). Luca Pacioli (1445-1517), the
father of modern accounting, published this method in his book Summa
de Arithmetica in 1494

Pacioli described the uses of three books: memorandum, ledger, and journal. Each
transaction was first noted in the memorandum, book, then listed in debit and credit
form in the journal, and then posted in the ledger.

Savary Commercial Code

(Historical Cost Method of Accounting)

Jacques Savary (1622-1690), came from a noble French family devoted to trade and to the
publication of works on commercial matters of lasting and widespread authority. He had a
wide experience in and out of royal service, and was known as the chief architect of the
Commercial Code of France in 1673 (called Code of Savary) which generally uses historical cost
as the basis of valuation. He published his book entitled The Perfect Merchant containing
1,700 pages describing accounting in Chapters 4 to 10 of Book Four.

Napoleonic Commercial Code

(Fair Value Method of Accounting)

Napoleon Bonapartes codification of Frances Civil Law named Code of Napoleon was
enforced in March 21, 1804.

Three years later (1807), the Code de Commerce was enacted as a supplement to the Code
Napoleon. It regulated commercial transactions, the laws of business, bankruptcies, and the
courts jurisdiction and procedures dealing with these subjects.

The Code of Commerce in 1807 does not provide for any rule of valuation but gives in notes
and example of inventory in which it is said that the assets must be carried at their market value on
the day of inventory and not on the basis of historical cost.

Schmalenbach and the Chart of Accounts

(Price Level Accounting)

Chart of accounts have played a vital role in the development of accountancy in Poland since
the World War II.

Eugen Schmalenbach (1873-1955), a writer and professor at Cologne believed that the firms
chart of accounts is not mere carrier of balances.

He believed that Chart of Accounts contains relevant dynamic information that can be prepared
promptly and regularly to quickly respond to the external and internal factors affecting the
economic flight of an enterprise.

Schmalenbach utilized price level accounting or uniform chart of accounts. Price, as the
basis of value, helped decentralize management to compare the firms performance and
financial condition with others in the same sector of economy. Pice seemed to be available as
control and corrective for investment decisions in planned or free economies.

Chapter 1: Introduction to Accounting

He also advocated that traditional accounting policies should be changed keeping with relevant
and reliable information that creates challenges satisfaction, and ingenuity of accountants.

Savary, Napoleonic, and Schmalenbach Valuation

In the history of accounting, there were several origins of valuation methods on how to measure
the worth of economic transactions.
Jacques Savary (1622-1690), in his Commercial Code of France (1673), used historical cost as the
basis of valuation.

Napoleon Bonaparte (1769-1821) Commercial Code (1804) and its supplement Code de Commerce of
France (1807), exemplified that assets must be carried at their market value (current/fair value
or replacement cost) and not on historical cost.

Eugen Schmalenbach (1873-1955) utilized price level accounting as the basis of valuation. It
means that the financial statements are restated in terms of general purchasing power using the
general price index.

To illustrate the three kinds of valuation, assume that A Co. purchased a portion of land in year
2010 for P100, 000. In 2013, an independent appraiser valued the land for a market value of
P250, 000. The price index from 2010 to 2013 is 3.0.

The land item in the Statement of Financial Position of A Co. will be reported as follows:
If the land is reported by:
Using: Savary Bonaparte Schmalenbach
Historical cost 100, 000
Market Value 250, 000
Price level (100,000 x 3) 300, 00 0

The use of historical cost is based on the principle of stability of monetary unit. The accounting
data should be verifiable and only the actual purchase price should be recorded in the financial
report to avoid distortion.

The fair value accounting is not an inflation accounting. It is used primarily to show the present
value of an item in the financial report. Accountants argue that a move to fair-value accounting
will provide information that is relevant to investors.

The price level accounting is synonymous with inflation accounting. Generally, this accounting
model converts historical cost into price level adjusted cost using general or specific price
indexes to reflect the effect of inflation in the financial report.
The Industrial Revolution and the Share-Issuing Company

The Industrial Revolution was a period in the late 18 th and early 19 th centuries when major
changes in agriculture, manufacturing, and transportation had a profound effect on socio-
economic and cultural conditions in Britain and subsequently spread throughout the world.

This period was marked by the use of powered all-metal machine tools for mass production, the
development of steam-powered ships, railways, and, later in the 19 th century the invention of
the internal combustion engine and electrical power generation. The resultant great strides in
economic progress greatly affected accounting practice.

Some accounting practices introduced during the Industrial Revolution are as follows:
Depreciation, allocation of overhead, inventory accounting;
Evolution of accounting for business organization such as sole proprietorship,
partnership, share companies, and stock exchange listed corporations; and
Increased government regulations on financial reporting and new tax accounting system
and procedures

The Arrival of Income Taxation and the Conflict with Financial Accountin g

In AD 10, Emperor Wang Mang (45 BC-AD 23 of Xin Dynasty) of China instituted the first
known income tax at a flat rate of 10% of profits.

In 1798, a graduated income tax system from 8.33% to 10% was first implemented in Britain by
William Pitt the Younger in his budget to pay for weapons and equipment in preparation for
the Napoleonic wars.

The first United States income tax was imposed in July 1861 with a rate of 3% of all income over
600 dollars.

The first Income Tax Law in the Philippines was made on March 1, 1913. At present, the
Philippine Government implements a graduated tax rate from 5% to 32% on net taxable income
of individual taxpayers. Starting 2009, the Philippine income tax rate on the next taxable income
of corporations would be 30%.

The arrival of the income tax laws was another major event in accounting history. Lawyers
naturally thought that since income tax returns were legal documents, they would have
exclusive rights to prepare them. Accountants argued that since the bulk of the wok in
preparing Income Tax Returns (ITRs) involved accounting calculations, thus, it is more
properly classified as accounting work.
US law firms in the 1920s were slow to include income tax preparations into their business
skills. Public accountants saw a new lucrative opportunity and jumped into tax work with
expertise. By the time the lawyers challenged the accountants for practicing law without a
license, income tax preparations had been so thoroughly identified with accountants, so much
so that the lawyer lost their case.
With the infusion of CPAs in taxation, a specialized field of accounting called Tax Accounting
was born. Here, the accountant provides services regarding tax computation, tax planning, and
tax consultancy to legally minimize tax payments of clients.

Also, several conflicts of taxation and accounting are remedied through the preparation of ITRs
for tax reporting purposes and preparation of financial statements for accounting reporting
purposes, and the preparation of a reconciliation of the two reports.

The Rise of the Group of Companies and the

Need for Consolidated Accounts
Since the end of World War II, there has been a rapid growth of domestic and multinational
corporations in various countries.

With the global trend of businesses, business enterprises expand not only by building new
facilities, but most of all by business combination or grouping or combining previously separate
business entities.

Business combination may be a merger or a consolidation. There is a merger when one company
takes over all the operations of another business entity resulting in the letters dissolution.

A consolidation occurs when a new corporation is formed to take over the assets and operations
of two or more separate business entities and those previously separate entities are dissolved.

This method of expansion is more economical, involves lesser risk, and makes the business
advantageous in terms of available resources, talents and expertise, and physical and
geographical operations.

Accounting for business combination is one of the most important and interesting topics in
accounting theory and practice. It involves financial transactions of enormous magnitudes
hose involving business empires, fortunes, executive geniuses, and management fiascos.

It is believed to be the most complex and controversial areas of accounting because each one is
unique and must be evaluated in terms of its economic substance, irrespective of its legal form.

Accountants prepare financial reports for these business combinations in consolidated financial
reports derived from consolidated accounts. These consolidated accounts are almost always
what matter to investors in evaluating their profit and loss, financial condition, and share in the
business as well as dividends.

Internationalization of Markets and Reporting

Nowadays, investors seek investment opportunities all over the world. Similarly, companies
seek capital at the lowest price anywhere.

As economies worldwide continue to globalize, the traditional borders associated with business
operations are disappearing, and business everywhere feel the need to operate globally to
remain competitive.

Financial markets, multinational businesses, labor markets, and overall capital flows ignore
geographic constraints and transcend national boundaries.

With the presence of international financial markets, some firms are raising capital and trading
in international market with the intention of increasing the firms liquidity.

For example, Amex shares are now traded in Singapore, while NASDAQ and London shares
are available in the Hong Kong Stock Exchange. Merger among some of the worlds largest
stock exchanges is continuously happening (such as Euronext, the combination of the stock
exchanges in Paris, Amsterdam, Brussels, and Lisbon.)

Investment and financial management decisions are complicated by the fact that different
countries have different currencies, tax regimes, and levels of political and economic risk.

Financial manager must account for all these factors when deciding which activities to finance,
how best to finance those activities, how best to manage the firms financial resources, and how
best to protect the firm from political and economic risks (including global tax and foreign
exchange risks.)

Governments and regulators are also catching up with these market and business trends. There
is a clear trend toward inter-dependency and interrelationships among regulators across
jurisdictions, and national policies are being crafted with an open eye towa rd global
consequences.

It is not surprising that accounting regulatory bodies require accounting practitioners to keep
abreast with the new knowledge, interpretation and practice of International Accounting and
Auditing Standards.
This is to ensure transparency and reliability and obtain greater confidence on accounting
information to be used by global investors for more rational investment decisions.

Benefits of Global Accounting Standards

The most cited benefits for a single set of global accounting standards are as follows:

Easier access to foreign capital markets

Increased credibility of domestic capital markets to foreign capital providers and
potential foreign merger partners.
Increased credibility to potential lenders of financial statements from companies in less-
developed countries.
Lower cost of capital to companies
Comparability of financial data across borders
Greater transparency
Greater understandability a common financial language
Greater cost benefits use of only one set of books
Reduced national standard setting costs
Ease of regulation of securities markets regulatory acceptability of financial
information provided by market participants
Continuation of local implementation guidance for local circumstances
Lower susceptibility to political pressures than national standards
Portability of knowledge and education across national boundaries
Consistency with the concept of a single global professional credential

ACCOUNTING VARIATIONS AMONG COUNTRIES

Differences of Accounting Practices. Accounting is a product of the complex interaction of

environment, socio-cultural, legal, political, education and economic conditions in a particular
country.

It is thus no surprise that although historical developments had a uniform effect on accounting
systems throughout world, there have been at least

as many accounting systems as there are countries and no two systems are exactly alike.

These accounting variations may due to the following factors:

Political and economic ties with other countries
Status of the accounting profession
 Existence of a conceptual framework (language, terminologies, valuation, currency and
recognition principles used)
Quality of accounting education
Type of reporting regimes
Type of business entity
Type of capital market
Type of legal system
Level of enforcement
Level of inflation

People and users of accounting information are not exactly alike. One basis of comparison is
between a macro-user oriented and micro-user oriented accounting system.

In macro-user oriented systems, government agencies particularly tax and economic planning
agencies are the principal users of accounting reports.
In micro-user oriented systems, a diverse set of capital providers is perceived to be the most
important user group of accounting reports.

The complexity of conducting international business operations across national borders each
with a different set of business regulations and often different accounting methods presents
an intimidating challenge for accountants and the professional bodies that that establish
accounting and auditing rules.

For multinational enterprises, the diversity of applicable accounting auditing and tax rules may
affect the enterprises ability to prepare reliable financial information.

Other international accounting and reporting matters, such as inflation accounting adjustments,
deferred tax accounting, and translation of foreign subsidiaries financial statements, also
arguably create disadvantages for some companies and the persistence of these differences puts
pressure on standard setters to work harder to achieve a uniform set of accounting standards.
Linkage of Tax Laws & Accounting Principles Requirements

Oftentimes, government regulations on taxation are in conflict with accounting standards.

There are temporary and permanent differences that result in the discrepancy in the amount of
financial accounting income from taxable income.

For example, some incomes (such as gain on life insurance and unrealized gain on trading
securities) are reported in accounting but excluded in the income tax returns because by their
nature, tax laws exempt them from taxation.

Some expenses (such as allowance provision for uncollectible accounts. Product warranty and
representation expense) are recognized in the preparation of financial statements but
disallowed or limited in the preparation of income tax returns.

A corporation is permitted to adopt one accounting method for income tax purposes and
another method for financial reporting purposes.

An important event in the historical development of this matter occurred in 1994, when the
Committee on Accounting Procedure issued A.R.B. No. 23 providing that the amount of income
tax expense for the year shown in the statement of comprehensive income may not necessarily
be the amount currently payable for income taxes.

As a rule, in the ITR preparation, the tax law must be observed; but for accounting purposes,
the applicable accounting standards must be followed in the preparation of financial reports.
Consequently, accountants are faced with new tax accounting systems and procedures. They
usually make a reconciliation of the accounting and tax reports.

Degree of Development of the Capital Markets

Differences in the degree of development of the capital markets in different countries and their
effect on the development and use of generally accepted international principles of accounting
affect a countrys disclosure requirements and financial reporting level.

These include whether the market is predominantly equity-oriented or debt-oriented, the level of
sophistication of financial instruments, and the level of globalization of capital markets.

A capital market is known to be equity-oriented when companies turn to the stock market ad
their main source of capital. This situation is predominantly applicable in the United States and
Canada.
When companies depend on bank financing as their primary source of capital, the market is
known to be debt-oriented. Germany, Japan and Switzerlands companies belong to this group.
The equity or debt orientation of companies has a significant impact on the financial reporting
both in substance ad in form.

The level of sophistication and globalization of capital markets impact financial reporting
because accounting has to keep us with finance in terms of drafting accounting rules for new
financial instruments.

The globalization of capital markets has also heightened the need to address harmonization of
financial reporting requirements. The accounting variations among countries and the need of a
ever-changing economy demand for internationalization of accounting and auditing practices.

HARMONIZATION OF ACCOUNTING STANDARDS

With the globalization of business and diverse accounting practice, efforts have been made to
harmonize accounting standards across countries. This has resulted in the creation of the
International Accounting Standards Committee (IASC) in 1973. In 2001, the International
Accounting Standards Board (IASB) succeeded the IASC.

The main objective of IASB is to develop a uniform set of high quality, understandable, and
enforceable global accounting standards. Its purpose is to achieve a higher degree of
comparability and the transparency of financial reporting to help the worlds capital markets
and other users make economic decisions.

The accounting standards promulgated by the IASC are called International Accounting
Standards (IAS) but those promulgated by the IASB are termed International Financial
reporting Standards (IFRS). Currently, the IRS consists of the following:
International Financing Reporting standards (IFRS)
International Accounting Standards (IAS)
Interpretations of IFRS and IAS

In 2002, the European Union (EU) required all publicly traded EU companies to adopt IFRD
starting 2005. Other non-European countries also changed their national accounting standards
to IFRS. Countries like the United States, Japan, Singapore, Taiwan, Thailand and others
retained some of their national standards but converged them closely w ith IFRS.

The Philippines decided to adopt the accounting standards issued by the IASC and IASB, with
the following appropriate terms:

Philippine Financial Reporting Standards (PFRS) corresponding to IFRS;

Philippine Accounting Standards (PAS) corresponding to IAS; and
 Interpretations of the PFRS/PAS corresponding to interpretations of IFRS/IAS.

As of 2007, at least 119 countries have already adopted the IFRS. The IASB projects that in 2011,
there would be at least 150 countries adopting the IFRS.

The Financial Reporting Standards Council (FRSC)

On November 18, 1981, the Philippine Institute of Public Accountants (PICPA), the national
professional body of CPAs in the Philippines, created the Accounting Standard Council (ASC)
as the accounting standard body in the Philippines, o establish and improve accounting
standards that will be generally accepted in the Philippines.

Basically, the accounting standards in the Philippines called Statement of Financial Accounting
Standards (SFAS) were US-based until the gradual adoption of IAS and IFRS in the Philippines
starting in 1997.

The decision to fully adopt the IAS was due to the following reasons:
1. Increasing globalization of businesses;
2. Recognition of IAS by the global financial institutions such as World Bank, World Trade
Organization and Asian Development Bank; and
3. Complete support by the Philippine Regulatory Agencies. (See succeeding discussion)

In 2004, the Philippine regulation Commissions (PRC) created the Financial reporting Standard
Council (FRSC), replacing the ASC. The FRSC was created to assist the Board of Accountancy
(BOA) to carry out its powers and functions provided under Republic Ac No. 9298, the
Philippine Accountancy Act of 2004.

The approved accounting standards of the FRSC are known as the Philippine Financial
Reporting Standards (PFRS) and Philippine Accounting Standards (PAS) which fully took
effect on January 1, 2005.

Philippine Regulatory Agencies

The following Philippine agencies regulate the financial reports and professional activities of
CPAs:
 1. Bureau of Internal Revenue (BIR) to ensure compliance of National Taxes (Income
Taxes and Business Taxes) and license requirements of all businesses.
2. Local Government Units (LGU) to ensure payment of local business taxes and other
local taxes such as community tax, real property tax and professional tax.
3. Security and Exchange Commissions (SEC) to keep an eye on the operation of all
kinds of corporation (profit or non-profit)
4. Bangko Sentral ng Pilipinas (BSP) to regulate the operations of all banks and business
imports and export activities.
5. Philippine Institute of Certified Public Accountant (PICPA) to protect the credibility
of CPA Certificated and unstill ideals of professionalism, ethics, and competence among
CPAs.

Professional Organizations of CPAs in the Philippines

The accounting profession in the Philippines has grown rapidly since its formal recognition
with the passing of the first Accountancy Law (R.A 3105) in 19 23.

This law formally recognized accounting as a profession by restricting its practice to persons
possessing a CPA certificate. It created the VOA, vesting it with the authority to conduct CPA
examinations, issue CPA certificates and regulate the practice of public accounting in the
Philippines.

As early November 1929, CPAs in the Philippines formed the professions national organization
called PICPA which is primarily formed to:

1. Protect and enhance the credibility of the CPA certificate

2. Maintain high standards in accounting education
3. Instill ideals of professionalism, ethics, and competence among accountants
4. Foster unity and harmony among its members

PICPA also functions as the policy-making body of the following accounting organizations
which as its implementing arms:

ACPAE Association of CPA in Education

ACPACI Association of CPAs in Commerce and Industry
ACPAPP Association of CPAs in Public Practice
GACPA Government Association of CPAs

The professional organizations of CPAs in the field of Management Accounting are as follows:
 PAMA Philippine Association of Management Accountants

This organization was established to provide its members with educational and professional
activities and knowledge regarding current practices and methods in management advisory
services.

PIMA Philippine Institute of Management Accounting

It is the PAMAs implementing arm to propagate and professionalize Management Accounting

in the Philippines. PIMA directs the Certificate in Management Accounting (CMA) Program.
Chapter 1 REVIEW QUESTIONS

Chapter Discussions:

1. Explain why accounting practice is as old as civilization.

2. What is the significant feature of the Massari Ledgers of Commune of Genoa in
1340?
3. What is the Florentine approach of accounting? What did it contribute in the present
system of bookkeeping?
4. What are the books discussed in the Suma de Arithmetica written by Luca Pacioli
in 1949? Explain the significance of each book.
5. What significant developments in the accounting practice have occurred during the
following period?
a. French Revolution (1700s)
b. Industrial Revolution (1760 1830)
c. Global Industrial Economy (1900s)
d. International Business Transactions and International Relationships of
Government (2000s)
6. Compare the Florentine approach from Venetian approach to reporting business
transactions.
7. Compare the Savary, Commercial Code from Napoleonic Commercial Code.
8. Discuss the significance of Schmalenbachs contribution to accounting.
9. How to remedy the conflict of Income Taxation and Financial Accounting reporting?
10. What is the difference of merger from consolidation?
11. What are the benefits of global accounting standards?
12. Why do accounting practices vary among countries?
13. What is the main objective of IASB?
14. What is the main function of FRSC?
15. What agencies regulate the financial reports and professional activities of CPAs?