DETAILED ACCOUNTING ASSUMPTIONS, PRINCIPLES & CONCEPTS

1. SEPARATE ECONOMIC - Keeping firm’s financial records separate from owner’s financial
ENTITIY records
- Bus. separate from owner
- Ex: I am a business owner of a laundry shop, I must exclude my
personal expenses in the records of the bus.
2. GOING CONCERN - Firm will continue to operate/ earn profit
- Ex: 3 years ago, N company purchased a machine for php 20,000. The
machine is expected to have no salvage value. Nevertheless, N company
continues to keep the asset’s cost in its accounting records and to
depreciate the asset over its nine years of useful life.
- Explanation: It can be assumed the asset purchased will contribute to
the PROFIT of the company for 9 YRS unless there is a clear
indication that expectations have changed
3. MONETARY UNIT - Assets, liabilities, revenues, and expenses have to be recorded at their
dollar values.
- The concept that records are kept in terms of money and the value of
money is stable.
- Ex: The inventories that the company purchased for resales have their
own values and can be measured in currency, USD. These kinds of
inventories could be recorded in the Financial Statements.
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4. PERIODICITY OF - Income should be reported in CERTAIN TIME PERIODS
INCOME - Ex: The Meta company incurs expenses of $1,200 during the first
quarter of the year. The cash for these expenses will be paid next
quarter.
- Explanation: The time period assumption requires Meta company to
disclose these expenses on the income statement for the first
quarter of the year.
5. HISTORICAL COST - Requires assets to be RECORDED at ITS COST at the time THEY ARE
BASIS REQUIRED
- businesses must record and account for most assets and liabilities at
their purchase or acquisition price
- Ex 1: Pam’s Restaurant, LLC was formed in 1945. It purchased a
building soon after in 1946 for $20,000. Total, some 50 plus years
later, Pam’s is still in business. The original building is still on the
balance sheet for $20,000 even though the current fair market value
of the building is well over $200,000. Pam’s will keep the building on its
balance sheet for $20,000 until it is either retired or sold.
- EX 2: Jeff’s Construction, LLC bought a piece of equipment in 2001 for
$10,000. Today this piece of equipment is only worth $2,000. Jeff
would still report the equipment at its purchase price of $10,000, less
depreciation, even though its current fair market value is only $2,000.
6. RECOGNITION OF - Requires revenue to be recorded only when it is earned/ service is
REVENUE rendered
- Ex 1: Marvin’s appliance store sold a 3 yr service contract on a ref
receiving the entire amount of cash at the time of sale
- Explanation: Since the payment is advance, you will divide the payment
by 3 (payment / 3 yrs)
- Ex 2: If a lawyer agreed to represent a client for $5,000 in cash and a
boat worth $10,000, the lawyer would record revenue of $15,000
because this is the total amount of assets he received for his services.

7. MATCHING PRINCIPLE - The matching principle is the concept that revenue and costs incurred
in earning that revenue should be matched in the appropriate
accounting period.
- that expenses should be recognized and recorded when those expenses
can be matched with the revenues (that those expenses helped to
generate)
- basically match EXPENSES AND REVENUE OKAY!!!!!!
- Ex 1: Angle Machining, Inc. buys a new piece of equipment for
$100,000 in 2015. This machine has a useful life of 10 years. This
means that the machine will produce products for at least 10 years into
the future.
- Explanation: According to the matching principle, the machine cost
should be matched with the revenues it creates. Thus, the machine is
depreciated over its 10-year useful life instead of being fully expensed
in 2015.
- Ex 2: Bajor Art Studio produces picture frames and sells them to
wholesalers like Michaels and Hobby Lobby. Bajor pays its employees
$20 an hour and sells every frame produced by its employees. Since
the payroll costs can be directly linked back to revenue generated in
the period, the payroll costs are expensed in the current period.
- Ex3: 3 years ago, N company purchased a machine for php 20,000. The
machine is expected to have no salvage value. Nevertheless, N company
continues to keep the asset’s cost in its accounting records and to
depreciate the asset over its nine years of useful life.
- Explanation: The machine will contribute to the production of the 9-
year useful life and costs should depreciated over that period.
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8. FULL DISCLOSURE - requires management to report all relevant information about the
PRINCIPLE company’s operations to creditors and investors in the financial
statements and footnotes FOOTNOTES!! DO FOOTNOTE ;-;
- Ex: According to the full disclosure principle, management should list
the loans along with terms, maturity dates, current portions, and
collateral obligations attached to the loans in the notes of the financial
statements.

9. MATERIALITY - Significance of an item in relation to a particular situation / set of

facts
- DON’T RECORD INSIGNIFICANT AMOUNT
- Ex1: A large company has a building in the hurricane zone during
Hurricane Sandy. The company building is destroyed and after a
lengthy battle with the insurance company, the company reports an
extra ordinary loss of $10,000. The company has net income of
$10,000,000.
- Explanation: The materiality concept states that this loss is immaterial
because the average financial statement user would not be concerned
with something that is only .1% of net income.
- Ex 2: Assume the same example above except the company is a smaller
company with only $50,000 of net income. Now the loss is 20% of net
income. This is a substantial loss for the company. Investors and
creditors would be concerned about a loss this big. To the smaller
company, this $10,000 would be considered material.
10. COST BENEFIT - Cost of gathering information to fully comply with an accounting
TEST principle or rule should be justified by a benefit that would result if
the preferred treatment is followed. (Example, creating a depreciation
schedule to depreciate the cost of a trash can or stapler)
- providing financial information in the financial statements must not
outweigh the benefit of that information to the users
- Ex 1: Big Towing, Inc. issues financial statements in January for its
prior year. These statements correct an error in the previous year’s
financial statements. The error was estimated to be $200,000. The
exact error amount is unknown and would cost approximately $50M to
exactly pinpoint.
- Explanation: The cost benefit principle states that Big Towing does not
have to find the exact amount of the error. A reasonable estimate is
 acceptable due to the high cost of researching the actual cost of
the error.
- Ex2: Paul’s Retail, LLC discovered that an employee was stealing from
its cash register. The amount is suspected to be over $1,000, but Paul
is not sure. It’s estimated that Paul would pay his accountant and
attorney $5,000 to dig through his records and discover the exact
amount of the theft.
- Explanation: In this case, it would not be beneficial for Paul to do
further research and sue his former employee.
11. CONSERVATISM - Concept that revenue & assets should be UNDERSTATED rather than
overstated
- You should always error on the most conservative side of any
transaction.
- Most of the time this means minimizing profits by RECORDING
UNCERTAIN LOSSES OR EXPENSES and NOT recording uncertain
or estimated gains.
- Example1: G company has decided to charge off as a loss the portion of
it’s a/r that it estimates will be uncollectible. The accounts involved
results from the current yr’s sales
- Explanation: Conservatism requires a/r should not be over stated
- Ex2: Assume Gold Guitar, Inc. is in the middle of a patent lawsuit. GGI
is suing Blue Guitar, Inc. for patent infringement and anticipates
winning a large settlement. Since the settlement is not certain, GGI
does not record the gain on the financial statements. Why? Because of
the GGI might not actually see this gain. It might not win, or they
might not win as much as it expected. Since a large winning settlement
might skew the financial statements and mislead the users, the gain is
left off the books.
- Explanation:

- Ex3: Assume the same example above except GGI anticipates losing
the lawsuit instead of winning it. If Blue Guitar, Inc. expects to lose
the suit; they should record the loss in the footnotes of its
financial statements. This would be the most conservative approach
because financial statement users want to know if the company will
have to pay out a large some of money in the near future.
- Explanation:
 - Ex4: Red Brick Records is getting ready to release a new album and is
unsure as to whether it owes a few artists on the record royalties due
to contracts and legal disputes. Red Brick should report the contingent
liability in the footnotes of the financial statements. If the record is a
hit, the record label could owe a large amount of money to its artists.
To be conservative, this should be shown in the notes.
12. INDUSTRY - Some industries have unusual tax laws or regulatory requirements and
PRACTICE so have developed special accounting principles and procedures for
their industry.
- This makes sense because every industry is different and faces
different financial reporting challenges
- Ex1: The agriculture industry reports its crops at their fair market
value on the balance sheet instead of the traditional historical cost or
production cost. This is common because calculating the actual cost per
crop is too difficult and costly. Its easier for farmers to value and
report their crops at the current market price.
- Ex2: For example, the financial statements of organizations will vary
somewhat if they are in the gaming, insurance, medical care, or utility
industries. These differences are allowed by the applicable accounting
standards, as long as the departures from common practice are
justifiable.
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