Accounting Principles and Practices Performed by Small Businesses in the Philippines

College of Business Administration Abstract: This research aims to gain the knowledge and awareness on the accounting practices done by small businesses. It aims to inform and learn about small businesses’ and their compliance to the standard practices of accounting in the Philippines, whether or not these businesses are following the basic accounting principles and what alternatives of accounting do they perform.And lastly, to provide recommendations to the businesses owners and other persons involved, on what accounting practice is more suitable for small businesses. Through the use a variety of reference materials, such as reference books, text books and internet sources, information related to the study has been compiled and put together to form the appropriate knowledge needed for the study.Through the findings, the researchers classified two types of accounting practices performed by small businesses: Formal Accounting, this accounting practice is based on the actual Phi lippine accounting standard provided by the IFRS, and a Semi-Formal Accounting, a combination of the IFRS accounting and the Single entry record system. Keywords: Accounting, Accounting Principles, Accounting Practices, Small Business, Small Business Accounting Introduction There are more than a million businesses spread throughout the Philippines.From high rising commercial entities in the big cities, to the smallest businesses found in the front yard of residential homes in rural or urban areas. Business can be defined as a person, partnership, or corporation that seeks to provide goods and services to others at a profit (Dias and Shah, 2009) Businesses are among one of the factors affecting the economic growth in the country. Generally, taxes and investments earned by these businesses, through the purchases of their consumers, are paid to the Government. Small and medium-scale enterprises (SMEs) play a significant role in developing economies.Among their contributions are as foll ows: (a) they address poverty by creating jobs and by increasing incomes; (b) they disperse economic activities in the countryside, and provide broad-based sources of growth; (c) they serve as suppliers and providers of support services for large enterprises; (d) they stimulate entrepreneurial skills among the populace; and (e) they act as incubators for developing domestic enterprises into large corporations. SMEs typically comprise the bulk of business enterprises in both developed and developing countries.They also employ a large segment of a country's workforce, and contribute significantly to national output (Habaradas, 2008) However, not all businesses contribute to the economic growth of the country especially for small independent businesses in private homes. Such examples are self-employed proprietors and street vendors whose businesses are not registered to the Bureau of Internal Revenue (BIR). Legally registered businesses (small businesses) on the other hand, contribute to the economic growth through payments of taxes collected by the Bureau of Internal Revenue.Such businesses record transactions or accounting information to keep track and allocate assets, liabilities and the owner’s equity. Through this accounting information, the owners will be able to allocate their assets for the expenses of tax payments. It may be said that the accounting practice is for formalities and usually performed by large business entities. However it is important for small businesses to apply the accounting practices in order to easily keep track and record important transactions especially those which concern large amounts of money.Accounting is important in achieving success in any business, especially a small one. Accounting is tied to the business’ financial well bing, without it, it will be hard to determine whether there is a positive or negative increase to the profit of the business. Accounting records must accurately reflect the changes occurrin g in the firm’s assets, liabilities, income, expenses and equity. The continued operation of a business depends on maintaining the proper balance among its investments, revenues, expenses and profit.Because profit margins are so critical to the success of a business, any decline should trigger an immediate search for the cause. Thus, the owner must rely on the accounting information to search this cause (Byrd and Megginson, 2009) The purpose of a business is to make a profit; proper business accounting helps determine how well the business runs. Accounting is the general process of tracking income and expenses and then using that data to examine the financial status of a business. (Strauss, 2005) The accounting practices performed by larger businesses are usually formal, specific and detailed and done by certified accountants.Small business accounting may be performed in various styles, with no formality and proper structure, and usually done by the owners themselves. A varie ty of accounting styles maybe derived from the informal accounting performed by small businesses. Some styles may have the same structure, making it similar to other businesses thus having slight uniformity. Review of Related Literature Small Businesses A small Business is any business that is independently owned and independently owned and operated, is not dominant in its field, and does not engage in many new or innovative practices.It may never grow large, and the owners may not want it to, as they usually prefer a more relaxed and less aggressive approach to running the business. They manage their business in a normal way, expecting normal sales, profits, and growth. In other words, they seek a certain degree of freedom and ideally a certain degree of financial independence. (Byrd ;amp; Megginson, 2009) Accounting Accounting is a service activity; Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be us eful in making economic decision.Accounting includes several branches, for example, financial accounting, managerial accounting, and government accounting. This statement deals with financial accounting for business enterprises, the branch of accounting that focuses on the general-purpose reports on financial position and results of operations known as financial statements. This Statement has two broad purposes: (A) to provide a basis for enhanced understanding of the broad fundamentals of financial accounting, and (B) to provide a basis for guiding the future development of financial accounting. n. d. , 1998) Financial statements are prepared and presented for external users by many entities around the world. Although such financial statements may appear similar from country to country, there are differences which have probably been caused by a variety of social, economic and legal circumstances and by different countries having in mind the needs of different users of financial sta tements when setting national requirements.The accounting conceptual framework, formerly known as the Framework for the Presentation of financial Statements by the IASC, serves as the foundation for the development of accounting standards by the International Accounting Standards board. It’s main objective is to narrow the differences in financial statements of different entities by harmonizing regulations, accounting standards and procedures relating to the preparation and presentation of financial statements. (Robles ;amp; Empleo, 2007) Structure of the Philippine AccountingThe Framework for the preparation and presentation of financial statements adopted in the Philippines is based on the International Accounting Standards Committee’s (IASC) Framework for the Preparation and presentation of Financial Statements. This was approved in the Philippines on January 26, 2000 by the unanimous vote of the members of the Accounting Standards Council (ASC). The ASC was the fun ctioning accounting standard setting body in the Philippines, when the Philippines decided to adopt the International Accounting Standards.The same Framework was upheld by the International Accounting Standards Board, when the latter succeeded the International Accounting Standards Committee in 2001. In the Philippines, the ASC was succeeded by the currently functioning Financial Reporting Standards Council (FRSC). The FRSC assists the Board of Accountancy in the latter’s function of adopting and promulgating the International Financial Reporting Standards. Thus, both the IASB and the locally functioning FRSC in the Philippines are guided by the same Framework. Robles ;amp; Empleo, 2007) The IFRS for SMEs The Philippine Institute for Public Accountants (PICPA) now recognizes the International Accounting Standards Board's (IASB) recently released International Financial Reporting Standard for Small and Medium-Sized Entities (IFRS for SMEs), as an official set of accounting sta ndards to be audited against. (Brozovsky, Christie & Hicks, 2010) The IFRS for SMEs was adopted in the Philippines effective January 1, 2010, and is known as the Philippine Financial Reporting Standards for Small-Medium Entities (PFRS for SMEs).The Philippine Securities and Exchange Commission (SEC) adopted a definition of â€Å"small and medium-sized entities† that includes a size criterion. As defined by SEC, an entity is an SME if: it is not in the process of filing its financial statements for the purpose of issuing any class of instruments in a public market and, it is not a holder of a secondary license issued by a regulatory agency, such as bank (all types of banks), an investment house, a finance company, an insurance company, a securities broker / dealer, a mutual fund and a pre-need company.The Philippines has been acknowledged by political scientists and economists as a newly industrialize nation. The country is experiencing rapid economic growth usually export -oriented and on-going industrialization. The Accounting Standards Council (ASC) is responsible for establishing and improving generally accepted accounting standards. Development of such standards are based on existing practices in the country, as well as statements and studies issued by other standard setting bodies like the International Accounting Standards Committee (IASC) and the Financial Accounting Standard Board (FASB).The ASC, which was renamed as the Financial Reporting Standards Council (FRSC) decided to replace its US-based standards with International Accounting Standards (IAS), later referred to as IFRS. The Philippines also adopted the International Financial Reporting Standards in 2005. It modified its accounting practices slightly to adjust to Philippine policies making the Philippine Financial Reporting Standard (PFRS), and the Philippine Accounting Standards (PAS).Businesses are fully aware of the changes from GAAP to IFRS, which now apply the new IFRS procedures , and modifications that were implemented taking effect in 2009. These companies are now preparing their financial statements in compliance with the PFRS. The Philippines has fully implemented the IFRS. In April 2010, The Philippines adopted IFRS for SMEs referred to as Philippine Financial Reporting Standard for SMEs. These standards can be used by an entity that is not a listed company, a large unlisted company, and a financial institution or public utility. (Ibarra & Suez-Sales, 2011)The International Accounting Standards Board ( IASB ) was established in 2001 as part of the International Accounting Standards Committee ( IASC ) Foundation. One of the objectives of the IASC foundation and of the IASB is: to develop, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that are require high quality, transparent and comparable information in financial statements and other financial reporting to help participants in the world’s capital markets and other users make economic decisions.The IASB also develops and publishes a separate standard intended to apply to the general purpose and other financial statements of, and other financial reporting by, entities that in many countries are referred to by a variety of terms, including small and medium-sized entities (SMEs), private entities, and non-publicly accountable entities. That standard is the International Financial Reporting Standards for Small and Medium-sized Entities (IFRS for SMEs).SMEs often produce financial statements only for the use of tax authorities or other governmental authorities. Financial statements produced solely for those purposes are not necessarily general purpose financial statements. (Alliance of Accounting and Auditing Researchers, n. d. ) Accounting Policies The IFRS for SMEs is indented for the use of small and medium sized entities (SMEs). Small and medium-sized entities are entities that do not have public account ability, and publish general purpose financial statements for external users.Examples of external users include owners who are not involved in managing the business, existing and potential creditors and credit rating agencies. Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements. If this IFRS specially addresses a transaction, other event or condition, an entity shall apply this IFRS. However, the entity need not to follow a requirement in this IFRS in the effect of doing so would not be material.If this IFRS specifically address a transaction, other event or condition, an entity’s management shall use its judgement in developing and applying an accounting policy that results in information that is relevant to the economic decision-making needs of users, and reliable, in that the financial statements represent faithfully the financial position, financial performance and c ash flow of the entity; reflect the economic substance of transactions, other events and conditions, and not merely the legal form; are neutral, i. . free from bias; are prudent; and are complete in all materials respects. An entity shall select and apply its accounting policies consistently for similar transactions, other events and conditions, unless this IFRS specifically requires or permits categorisation of items for which different policies may be appropriate. If this IFRS requires or permits such categorisation, an appropriate accounting policy shall be selected and applied consistently to each category.An entity shall change an accounting policy only if the change is required by changes to this IFRS, or results in the financial statements providing reliable and more relevant information about the effects or transactions, other events or conditions on the entity’s financial position, financial performance or cash flows. (Alliance of Accounting and Auditing Researchers, n. d. ) Need of Accounting Information for Small Businesses In order to operate a business effectively, the owner should be informed as to the nature and amount of each asset, each liability, and the amount of owner’s equity.For purposes of planning and controlling business operations, the owner should also know when, why and how frequently changes occurs in the various assets, liabilities and the owner’s equity of the business. Without written records, business owners are not able to keep track of the nature and the amount of the assets, liabilities, and owner’s equity and the changes that occur in their composition. A good record keeping system is usually essential to provide the necessary information.This system of record keeping should show the effect of each transaction on the assets, liabilities and owner’s equity of the business. (Taylor, 2003) Proper Business Records There are several reasons (and advantages) for keeping good business records, an d many of them are a real a real advantage: (1) to show financial standings, (2) to help make important financial decisions, (3) to help control VAT – collecting it in and paying it out, (4) to help audit in certain cases, and keep the auditing costs down, (5) to discuss your financial position with other people.Unless the owners decide otherwise, there is no legal need for an annual audit of the records of a sole trader or a partnership. There is, however, a legal obligation for an annual audit of the accounts of most limited companies. There will be some expenses which are partly for business and partly for private purposes. Recording of business transactions also depends on the size of the business. There can be no hard and fast categories for size of a business. But obviously a national chain store will have a more sophisticated accounting system than a local trader with a market stall.The point at which more complicated records needed, will also depend partly on the type of trade. There are three types of entity commonly found running a business. These are: Sole traders, Partnerships and Limited Companies. Sole traders are persons owning the business which he is running in his own right. Since the person is trading in his own right he is personally responsible for any debts his business incurs. Partnerships are groups of people owning and running the business. It is the individuals in the partnership who are responsible for the partnership debts.Limited Companies are businesses which are owned by at least two people who may or may not also be involved in the day-to-day running of the business. The owners have a limited personal liability for the debts incurred by the company which is a separate legal ‘person’ or entity. The day-to-day running of a limited company is entrusted to its directors. The directors of a company may also be the shareholders. (Taylor, 2003) Businesses can also be classified into three broad categories: public co mpanies, private companies, and small businesses.The distinction between the latter two is the size of the company. Though small, these businesses are important in the aggregate as the major creator of new jobs. Small businesses also constitute a major source of clients for local and regional CPA firms. The need for accounting reports varies among the three classes of businesses. Accounting reports are used to comply with various government reporting requirements. Primary among these is the need to report a business's income, personal property, and payroll to the necessary tax authorities.The relative importance of different uses of accounting reports varies with the size of the business. (Brozovsky, Christie ;amp; Hicks, 2010) Accounting Principles and Practices Most businesses typically use one of two basic accounting methods in their bookkeeping systems: cash basis and accrual basis. While most businesses use the accrual basis, the most appropriate method for a company depends on the sales volume, whether or not you sell on credit, and your business structure. The cash method is the most simple in that the books are kept based on the actual flow of cash in and out of the business.Income is recorded when it is received, and expenses are reported when they are actually paid. The cash method is used by many sole proprietors and businesses with no inventory. From a tax standpoint, it is sometimes advantageous for a new business to use the cash method of accounting. That way, recording income can be put off until the next tax year, while expenses are counted right away. With the accrual method, income and expenses are recorded as they occur, regardless of whether or not cash has actually changed hands. An excellent example is a sale on credit.The sale is entered into the books when the invoice is generated rather than when the cash is collected. Likewise, an expense occurs when materials are ordered or when a workday has been logged in by an employee, not when t he check is actually written. The downside of this method is that payment of income taxes on revenue are made before actually receiving it. The accrual method is required if annual sales exceed $5 million and the venture is structured as a corporation. In addition, businesses with inventory must also use this method.It also is highly recommended for any business that sells on credit, as it more accurately matches income and expenses during a given time period. The cash method may be appropriate for a small, cash-based business or a small service company. (Leonsky, 1998) Accounting is the general process of tracking your income and expenses and then using that data to examine the financial status of your business. The basic accounting tool is the general ledger. It is the place where you keep track of all the business’ financial transactions.That information is then used to create financial statements such as balance sheets and income statements. (Strauss, 2007) An accounting system structures the flow of financial information to provide a complete picture of a firm’s financial activities. There are two types of accounting systems performed by small businesses: (1) the single-entry system and (2) the double-entry system. The single-entry record-keeping system is occasionally still found in the very small business. It is not, however, a system recommended for firms that are striving to grow and achieve effective financial planning.A single entry-system neither incorporates a balance sheet nor directly generates and income statement. A single-entry system is a check book system of accounting reflecting only receipts and disbursements. A double-entry system is a type of accounting system that provides a self-balancing mechanism in the form of two counterbalancing entries for each transaction recorded. It can be done with the record-keeping journals and ledgers found in most office supply retail stores. However, the relatively simple accounting softwa re programs designed for small firms are preferable. Longenecker, 2006) Conclusion Based on the information gathered by the researchers, the researchers have come up with a conclusion to the stated problem. The researcher has classified two types of accounting practice/principles performed by small businesses namely: Formal Accounting and Semi-Formal Accounting. Formal Accounting practice are based on the standards of the International Financial Reporting Standard for Small and Medium-Sized Entities (IFRS for SMEs) The IFRS for SMEs is indented for the use of small and medium sized entities (SMEs).Small and medium-sized entities are entities that are defined as not having public accountability, and do not publish general purpose financial statements for external users. The Semi-Formal Accounting practice is a combination of the Formal Accounting Practice (based on the IFRS for SMEs), and the Single-entry record keeping or booking keeping system. In the Single-Entry system, mostly pe rformed by small businesses, business owners record only the most important or essential transactions for the business which usually contain only the following: cash, accounts receivable, accounts payable and taxes.However, by performing this system, the owners still apply some of the standards given by the IFRS for SMEs. Most businesses however, perform only the Single-entry system. It is a much easier and convenient accounting practice that is preferable by the owners of small businesses because of its comprehensiveness in storing only the important accounting information needed by such businesses. Recommendation The Single-entry system, for most business owners, is mostly performed for its convenience and completeness. The researcher recommends, however, for the owners to apply the Formal accounting practice.The IFRS for SMEs, established by the IASB, was made specifically for small businesses to use. This accounting standard is best recommended for small businesses to attain uni formity among all other businesses alike. This will not only provide advantage to the owners but also to the users of the accounting information. It is still reminded that smaller businesses; such as vendors, sari-sari stores, restaurants or eateries; are not recommended to perform such complicated accounting practice but, they are still advised to record accounting information.The recommended accounting practice for such businesses is the Single-entry system. The researchers provide further recommendations toward the persons involved: 1. To the Business Owners of small businesses, they must obey and follow the accounting standards of the International Financial Reporting Standard for Small-Medium Entities (IFRS for SMEs), mentioned in this research, to attain uniformity among other small businesses which practice the accounting standard of the IFRS. 2.To the College of Business Administration and its faculty members, in which they can use this research as an instructional material or instrument in teaching their students about topics relating to the research. 3. To the Graduates of the College of Business Administration, who plans to have their own business or put up a small business; that this research may serve as a reference and as a guide for their first steps in being entrepreneurs. 4. To the Students of the College of Business Administration, in which they can use this research as a reference material to their academic studies.Bibliography 1. Alliance of Accounting and Auditing Researchers. (n. d. ). 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A comparison of the International