CHAPTER 3

Accounting’s Role in Business

Learning Objectives

After you have completed this chapter, you should be able to do the following:
1. Explain why it is important for business managers including hospitality to understand the
basic theory and practice of accounting.
2. Explain the fundamental function and purpose of accounting, and differentiate it from
bookkeeping.
3. Differentiate between a balance sheet and statement of income and cite the importance and
relationship of the financial statements .
4. Explain the difference between external users and internal users of accounting information in
terms of their various interests.
5. Understand the different branches of accounting.
6. Describe the role of the certified public accountant in performing the audit function.

Accounting is an interesting field of study that has many uses in society. Accounting is often
called the “language f business” because when confronted with events of a business nature, all
people in society – owners, managers, creditors, employees, lawyers, engineers, and so forth –
must use accounting terms an concepts in order to describe these events. It is therefore logical
that anyone entering the business world should know enough of the “language” to communicate
with others and to understand their communications.

Many of those presently involved in the hospitality industry and many students new to the field
of hotel and restaurant management feel that the language of business or accounting is
understood only by specialists who are “number oriented”. These misconceptions arise from
unfamiliarity with the fundamental purpose of accounting and the logic which lies behind basic
accounting activities.

This book will dispel many misconceptions about basic accounting activities and will address
the importance of understanding the theory and practice of accounting for managers, supervisors,
and students who are new to the field of hotel and restaurant management.

Why Study Accounting?

As you acquire knowledge of accounting, you will gain understanding of the way businesses
operate and the reasoning involved in the making of business decisions. Even if you are not
involved directly in accounting activities, most assuredly, you will need to be sufficiently
acquainted with the “language” to be able to understand the meaning of accounting information,
how it is compiled, how it can be used and what its limitations are.
The Basics of Accounting for Hotels and Restaurants

Furthermore, in the highly competitive field of hotel and restaurant management, successful
careers often depend on an ability to make daily operating decisions based on analysis of
financial information. For example, decisions concerning the allocation of capital or resources
such as whether to buy new kitchen equipment, whether to offer a new product or whether to
advertise to stimulate business activities will require the use of accounting information.

What is Accounting?

Accounting is the system that measures business activities or transactions, processes that
information into reports and communicates the results to decision makers. Business transaction
is an event that has a direct effect on the operation of the economic unit and can be expressed in
terms of money. Examples of business transactions are buying and selling goods, renting a
building, paying employees, buying new office equipment and any other activity of a business
nature that involves exchange of values in monetary terms.

The accountant analyzes these business transactions, processes that information into reports, and
communicate the results to decision makers. The key products of an accounting information
system are the financial statements that allow people to make informed decisions.

Financial Statements

Financial statements are the documents that report on an individual’s or an organization’s

business in monetary terms. Intelligent answers to business questions such as

Am I earning profit on my restaurant?

Can I afford to hire more waiters?

Ho much do I owe my creditors?

are basically based on accounting information.

The two major financial statements prepared by the accounting department are the
a. Statement of Financial Position (also known as the Balance Sheet), and
b. Income Statement.

Statement of Financial Position

The Statement of Financial Position or the Balance Sheet provides important information
regarding “the financial position of the hospitality business on a given date”. This statement
reports the assets, liabilities, and equity on a given date. Simply stated,

Assets represent anything a business owns which has commercial or exchange value. These are
economic resources of a business that are expected to be of benefit in the future. Examples of
assets are cash, office supplies, food inventory, furniture, land, and building.

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Liabilities represent the claims of creditors on the assets of the business. These are economic
obligations or debts payable to outsiders. Examples of liabilities are amounts owed to suppliers
of food supplies, amount due to a bank for a loan obtained from it.

Equity represents the claims of owners on the assets of the business.

Income Statement

The income statement provides important information regarding “the results of operations for a
stated period of time.” The statement reports the revenues generated, costs and expenses
incurred and the resulting net income or loss for the period. Because this statement reveals the
net income for a specifies period, it is ne of the most important financial statements used by
managers to evaluate the success of operations.

Another statement called “Statement of Owner(s)’ Equity” may be prepared for sole
proprietorship and partnerships to account for the change in the share of the owner(s) in the
business.

Importance and Relationship of Financial Statements

The owners and managers of a business look on their financial statements as a coach looks on the
scoreboard and team statistics as showing the results of the present game as well as the team’s
standing. The owners and managers can use the figures on the financial statements to plan future
operations. Owners and managers are not the only ones interested in financial statements.
Creditors, prospective investors and government agencies are also interested in the profitability
and financial standing if the business. Financial statements provide the means of taking the pulse
of the business. The income statement shows the results of operations for the current month or
year. It summarizes the results of operations into one figure, either net income or net loss.

The income statement is prepared first so that the net income can be recorded in the statement of
owners’ equity which comes next. It shows why – and – how the owner’s investment has
changed. The ending capital in the statement of owners’ equity is used in the statement of
financial position, which shows the present standing or the financial position of the business. All
this relationships are shown in figure 3.1.

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Figure 3.1. Relationship of the Financial Statements

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Accounting versus Bookkeeping

The term bookkeeping has sometimes been confused with accounting. The accounting process
includes several phases, including identifying, measuring, recording, retaining, and
communicating information. Bookkeeping is the process of recording accounting information for
a company according to a standard set of steps. Thus, bookkeeping is only one phase (i.e., the
recording phase) in the accounting process. A person who understands bookkeeping may not
necessarily be knowledgeable of accounting, but an accountant must always have a thorough
knowledge of bookkeeping. In addition, a user of accounting information will find a basic
knowledge of bookkeeping helpful in understanding the accounting information about a
company.
Accounting includes bookkeeping but goes well beyond it in scope. The accountant sets up the
system by which business transactions are to be recorded by a bookkeeper, prepares financial
statements, analyzes and interprets financial information, conducts audits, prepares special
business and financial studies, prepares forecasts and budgets and provides tax services.
Users of Accounting Information
The users of accounting information may be categorized into two groups namely, external users
and internal users.
External users. These are persons and groups outside the business and include the owners,
creditors, prospective investors, suppliers, government regulatory agencies (e.g., Securities and
Exchange Commission), taxing authorities (e.g., Bureau of Internal Revenue, Customs
Authority), labor unions, employees, and financial analysts who offer investment assistance such
as consultants, bankers and so forth.
Suppliers want financial information prior to extending credit to the hospitality operations.
Investors and stockholders make decisions to buy, sell heir investments or hold on information in
the financial statements. Bankers require financial statement prior to lending funds for building,
remodeling or other major purchases of the hotel or restaurant. Various government agencies
require financial statements of the business firm to determine whether it is complying with tax
and government regulations.
Internal users. These include those inside the hospitality business such as the board of directors,
all levels of management, including departmental supervisors, divisional and regional managers
and “top management” in areas such as sales, production, personnel, finance and computers.
Hospitality managers require accounting information for their long-term analysis and planning
and control of the hospitality operation. They need information regarding the results of
day-to-day operations that is provided by the major financial statement. On a day-to-day basis,
some department managers may need information to guide them in their operations. Thus, an
accounting department generally prepares an assortment of reports for various levels of
management.
Accounting Information and Decision Making

The role of accounting information in the decision-making process is illustrated in Figure 3.2.
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Figure 3.2. Accounting Information: Economic Activities and Decision Making

The above illustration shows the interactive nature of the accounting process; that is, accounting information about entities is
accumulated (identified, measured, recorded, and retained) and communicated to both internal and external users to assist them in
decision making. Their decisions, intern, have an impact on the economic entity, and the accounting information accumulation and
communication process is repeated. For example, a company intends to apply for a bank loan to supplement their current working
capital needs. Prior to such decision, the company will have to get information as to their other current debts. Based on its analysis of
the company’s financial position, it may decide not to pursue the bank loan anymore but instead to sell some other properties which it
does not need in their operations. By doing so, it may be able to generate cash without incurring additional debts. After the decision,
future activities of the business will change and in turn, result in different accounting information about the business.

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Branches of Accounting

Accounting has many branches or specialties.

A. Financial Accounting
Financial Accounting is used by business managers to record transactions of the business,
prepare reports based on those transactions, and thus communicate to owners’ and creditors
the current condition of the company and its success or lack of success. These reports are the
all-purpose financial statements such as the Balance Sheet Statement, the Income Statement,
and the Statement of Cash Flows.

This book is concerned with financial accounting for hotels and restaurants. Although
financial reporting ca be used internally, the focus will be on the accounting reports made by
these entities to those outside of the company.

B. Managerial Accounting

Managerial Accounting is used to aid business managers in planning and controlling business
operations and n decision making. For example, the decision to open a branch restaurant
requires the use of managerial accounting.

C. Tax Accounting

Tax Accounting is used to prepare tax returns and to examine tax consequences of proposed
business transactions.

D. Not-for-profit Accounting

Not-for-profit Accounting is used by nonprofit organizations (such as NGO’s, civic and

charitable institutions) to measure the success of their activities and to ensure strict
compliance with all requirements imposed by law, by donors, or by the entity’s purposes.

E. Governmental Accounting

Governmental Accounting is used by all branches of government and by those who receive
government funds to oversee the complicated business of providing government services or
to report to the government on the use of government funding in compliance with the
imposed relations.

The Role of the Certified Public Accountant (CPA)

A certified public accountant (CPA) in an individual who has met the educational and experience
requirements prescribed by law and has passed the Philippine Licensure Examination for CPA’s.

Depending on the size and type of organization (partnership, corporation) the law requires that
the business firm should have their financial statements “audited” or “examined” by an

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independent Certified Public Accountant. Financial institutions, such as banks, may also impose
this audit requirement in processing loans applied for the business entity. An audit is a
comprehensive investigation by an independent CPA of a company’s records and financial
statements. The objective of an audit is to arrive at a conclusion as to whether the financial
statements were prepared in accordance with generally accepted accounting principles. This
conclusion is embodied in the audit report which contains “opinion” of the CPA. The audit report
helps the user determine whether the financial statements can be relied upon or not.

REVIEW QUESTIONS
I. Questions
1. What is accounting?
2. What is the definition of a business transaction?
3. What is the principal purpose of accounting?
4. Describe the two major financial statements.
5. What are uses of accounting information presented in the financial statements?
6. Who are the external users of the financial statements?
7. Who are the internal users of the financial statements?
8. What is the difference between accounting and bookkeeping?
9. Describe the branches of accounting?
10. What is the audit function as performed by a certified accountant?

II. Multiple Choice

1. Which of the following is an example of an internal user of a hospitality business
financial information?
a. the firm’s board of directors c. the general managers
b. department managers d. all of the above

2. Which of the following statements about bookkeeping is true?

a. Bookkeeping is the last step in processing financial data.
b. Bookkeeping and accounting are two different names to essentially the same
process.
c. Bookkeeping is a clinical procedure that records and classifies business
transactions.
d. The fundamental purpose of bookkeeping is to provide useful and timely financial
information.

3. Which of the following is usually unnecessary in order to use accounting information to

make economic decisions?
a. The ability to prepare the accounting information.
b. The ability to understand the business environment in which the accounting
information is generated.
c. The ability to understand the economic environment in which accounting
information is generated.
d. A willingness to devote the time and energy required to make use of the
accounting information.

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4. The broad categories of economic decision making are:

a. Informed and uninformed users of accounting information
b. Preparers or users of accounting information
c. Those who own and those who lend, based on accounting information
d. External and internal users of accounting information

5. The internal decision makers make decisions:

a. About a company, rather than for it.
b. With limited access to accounting information concerning the company about
which they are making decisions.
c. On behalf of a company, such as what products to sell, at what price to sell, or
whether to automated production.
d. About a company such as whether to invest in the company, whether to lend to the
company, or whether to buy from or sell to he company.

6. External decision makers make decisions:

a. About a company, with limited access to the company’s accounting information.
b. For a company, such as whether to sell a particular product, at what price to sell it,
or whether to automate production.
c. For a company, such as whether to borrow from a bank or issue stock to investors.
d. About a company, with almost unlimited access to the company’s accounting
information due to the Freedom of Information Act.

7. The common match up between the type of decision maker and branch of accounting
typically providing information for that decision the maker is:
a. Internal and financial c. external and managerial
b. External and financial d. none of the above

8. Management accounting refers to accounting information generated primarily for use by:
a. External decision makers c. internal decision makers
b. Potential investors d. the company’s auditors

9. Financial accounting refers to accounting information generated primarily for use by:
a. Internal decision makers b. the chief financial officer
b. External decision makers d. upper level management

10. A net cash flow refers to:

a. Cash flow in exceeding cash flow out or cash flow out exceeding cash flow in.
b. Cash inflows exceeding cash outflows only
c. Cash outflows exceeding cash inflows only
d. Either cash inflows or cash outflows

11. A return of your investment refers to:

a. Recovering the amount of cash you originally invested.

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b. Recovering interest on the amount of cash originally invested.

c. Recovering the amount of cash originally invested and the interest earned on the
original investment.

12. The financial tool that focuses on the present condition of a business is the:
a. Polaroid camera c. balance sheet
b. Income statement d. cash flows statement

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