ONLINE LEARNING MODULE

ACCT 1026 (Financial Accounting and Reporting)

Academic Year 2020-2021

Lesson 2: ACCOUNTING CONCEPTS and PRINCIPLES

Topic: a. Definitions
b. Basic Accounting Concepts
c. Accounting Standards
d. Conceptual Framework for Financial Reporting
e. Definition: Qualitative Characteristics of useful Financial Information
f. Fundamental Qualitative Characteristics
g. Enhancing Qualitative Characteristics

Learning Outcomes: At the end of this module, you are expected to :

1. Differentiate from each other the terms used in this topic such as
accounting concepts, principles, standards, assumptions, etc.
2. Enumerate and Explain the Basic Accounting Concepts.
3. Define and Explain Accounting Standards.
4. Know the concepts and principles that form the framework base for
preparing financial statements
5. Apply the concepts in solving accounting problems.

A person engages in business to earn profits as a means of livelihood. To attain this objective, it is necessary
for him to check from time to time if he has achieved this goal by reading the financial statements. The financial
statements are the end products of accounting that will tell a story about the solvency and liquidity of a certain
business. It is equally important for the accountant to understand the accounting procedures and principles on
how to clearly and accurately communicate financial messages to the users of financial information. Let me
emphasize on the two (2) words clearly and accurately. In the absence of clear and accurate financial
information, the accounting exercise losses its purpose which is, communication.

As future accountants of this country and the world, I hope you understand that in practice of accountancy,
garbage in and garbage out, do you understand?

Accounting plays a crucial part in business and because of this, accounting is often referred to as the language
of business.

Along this line, we are about to learn the rules of thumb in accounting. Yes, there are rules and procedures to
follow to come up with a meaningful and useful financial statements. Imagine a beauty contest with no rules,
monkeys or dogs could be winners or anybody can be a winner. Thus, this contest losses its credibility. Just
like in accounting, we follow certain rules.

Before we will go the main topics, let us start with some definition of terms to improve your understanding and
appreciation of the world of accounting.

Definition of Terms:

Accounting Concepts – are a collection of ideas representing the theoretical foundation of the accounting
discipline. It is the basis of the conceptual framework for the principles that provide a general and practical
reference for procedures and methods applicable to certain situations and problems in accounting.

Accounting Principles are a collective and coherent set of rules or doctrines that have been developed by
customs, usage, experience logic and practical necessity; and have gained general acceptance in the
accounting profession. These principles provide guidelines for recording and reporting, as well as, in the
interpretation and evaluation of financial information.

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https://www.slideshare.net/jay29jay/generally-accepted-
accounting-principles-8495327

Accounting Standard – is a common set of principles and procedures that define the basis of financial
accounting. Accounting Standards improve transparency of financial reporting across all countries.
International companies follow the International Financial Reporting Standards (IFRS). The Philippines adopted
the IFRS or its local version as Philippine Financial Reporting Standards (PFRS)

Note: The full discussion on IFRS, PFRS and related topics will be elaborated in CFAS).

The terms concepts, principles, standrards postulates are often used interchangeably in practice. But the term
“standards’ specifically refer to the Philippine Financial Reporting Satbdards (PFRSs).

Traditionally, accounting standrards were referred to as the GENERALLY ACCEPTED ACCOUNTING

PRINCIPLES (GAAP)

GAAP encompass the conventions, rules and procedures necessary to define what is accepted accounting
practice.

Basic Accounting Concepts:

1. Separate Entity Concept – the business is viewed as a separate entity from the owner. This is the most
basic concept in accounting that we account the personal transactions of the owner separately from the
business.

An example is when the owner gets money from the Cashier to pay his utility bills for his home, it is recorded
as a cash advance of the owner or regarded as Owner Drawing instead of recording it as an expense of the
business. Or another example is when the owner gets money to pay for his children’s tuition fees, is regarded
as Owner’s drawing instead of recording this as a business expense.

In other words, we put a dividing line between the business and the owner. The business, although it is
composed of the owners and its various stakeholders, we view them as separate from the other. It is like
treating the business as another person. This is with the intention of “fair presentation” of fiancial statements.
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I hope we are clear on that.

https://www.slideshare.net/PoojaAdake/accounting-concept

2. Historical Cost Concept – assets are initially recorded at their acquisition cost regardless of whether you
can sell them at a higher price versus its cost immediately after its acquisition. As a rule, market values are
ignored.

3. Going Concern Assumption – the business is assumed to exist for an indefinite period of time. Under the
going concern assumption, the entity has neither the intention nor the need to enter into liquidation or to
cease operations. Hence, the financial statements are prepared based on this.

Liquidation, by the way, is the opposite of going concern and if such a condition exists, the presentation and
basis of preparing the financial statements will no longer be based on historical costs.

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4. Matching Principle – requires that the expenses incurred during a priod be recorded in the same period in
which the related revenues are earned, associating cause and effect.

A classic example is the sales and purchase of goods and services. If we sell a product in 2020, we also
record the cost of purchasing the same product in 2020. In that manner, the revenue is properly matched with
the expense. Matching principle is based as the ‘cause and effect’ relationship.

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5. Accrual Basis of Accounting – this is the more acceptable method of recording transactions as
compared to the cash basis of accounting. Under this method, Income is recorded when earned and expense
is recorded when incurred.

Let us take a look at cash basis accounting.

If you are a contractor with a project that is already completed but awaiting collection, you do not record
any income unless it is collected in cash, ‘already in the bag’.

Under accrual basis:

If you are a contractor with a project that is already completed but awaiting collection, you will recognize
the income and related expenses when the project is completed.

Is there any difference?

Yes there is. Under the cash basis, income and expense accounts maybe over or understated. If such a
case occurs, your financial statements may not present fairly the true performance of the business.

Given the two methods, accrual basis is the more acceptable practice. By the way, Philippine Taxation uses
the cash basis of accounting.

6. Prudence (or conservatism) – “Do not count your chickens until the eggs are hatched”

Are you familiar with the saying? In accounting we also practice that. In the presence of uncertainties,
provide for all possible losses/expenses and minimize the recognition of income. Or stating it in another way,
recognize revenues only when they are assured of being received.

An example is when a business is in the process of a lawsuit. It is uncertain if the business will
win or loss. In the midst of this uncertainty, under the concept of conservatisim, an amount should
be recognized in its books to provide for the possible losses.

7. Time Period – in accounting, the unlimited life of a business is divided into meaningful periods, namely:

a) Calendar Period – follows the calendar, starts its accounting cycle in January and ends in
December.

b) Fiscal Period - starts in any month except January and ends in any month except December.

A period that is less than 12 months is an interim period that can be three months or six month (semestral)

Observing time periods is necessary for the preparation of financial statements. The stakeholders will be
interested to know the performance of the business through the use of financial statements.

We do not wait for the business to stop operations to prepare the financial statements. Therefore, Financial
Statements are prepared periodically.

8. Stable Monetary Unit – in accounting, we view the Philippine peso or any other currency as a stable
currency. We do not recognize changes in purchasing power due to effects of inflation.
Hence, financial statements are prepared without regard for changes in purchasing power.

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An example, if ABC company purchases a tract of land for P250,000 in 2007. In 2012, there was political
unrest, the economy plunged into deep inflation that the value of the land if sold in 2012 will be triple its
original price. As a matter of practice, the business will not revalue its tract of land because of this.

9. Materiality Concept – When is an item material?

Information is material if its omission or misstatement could influence the economic decisions of users taken
on the basis of the financial statements (IASB framework)

Materiality relates to the impact or significance of transactions, balances and errors in the financial
statements. It defines a threshold or cutoff point after which financial information becomes relevant.

Materiality is a practical rule in accounting that strict compliance with GAAP is not required if the items involved
are not significant enough to affect the decision of an informed user.

.
There are two (2) factors to determine Materiality:

1) Relative size of the item in relation to the group

where the item belongs.

2) Nature of the item – an item may be material

because by its nature it affects economic
decisions

Accountingplay.com

10. Cost – benefit (Cost Constraint) - The term cost / benefit constraint states the cost of providing
information must be measured against the benefit derived from the use of that same information.

An example is when a bank teller cannot locate a difference of P0.10 in her transactions, the Accountant or his
superior will normally advise the Teller to declare a cash shortage/overage of the same amount instead of
incurring overtime expenses an additional cost of power and light just to locate an immaterial error of P0.10.

In other words, when we incur a cost, the expected benefit should always be higher than the related cost.

11. Full disclosure - another word for full disclosure is transparency. In accounting parlance, full disclosure
means that all significant and relevant information leading to the preparation of financial statements shall
be clearly reported.

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 In other words, adequate disclosure is
best described by disclosure of any
financial facts significant enough to
influence the judgment of the informed
users of financial information. Some
disclosures are found under the Notes
to Financial Statements.

The Accountant shall disclose a

material fact known to him which is not
disclosed in the Financial Statements
but disclosure of which is necessary in
order that the statements would not be
misleading.

https://www.slideshare.net/wahidsajol/intermediatefinancial-accounting-recognition-measurement-
concepts

12. Consistency Concept – accounting policies adopted by the business should be applied in a consistent
manner from one accounting period to another period. Stated differently, like transactions must be
accounted for in the same manner from one accounting period to the other. But this does not mean that
we cannot change accounting policies. Of course, we can, provided that, a) it is required by a
standard and b) the change would result to a more relevant and more reliable information.
However, any change in accounting policy must be disclosed.

Next topic –

The Conceptual Framework for Financial Reporting

Conceptual Framework – is a summary of the terms and concepts that underlie the preparation of financial
statements. It is an attempt to provide an overall theoretical foundation for accounting which will guide
standard setters, preparers and users of financial information in the preparation of financial statements.

The conceptual framework is not a standard. It serves as a reference in developing and applying the
standards. In cases of conflict, The Philippine Financial Reporting Standards shall prevail.

The conceptual framework is concerned with general purpose financial statements. Special purpose financial
reports, computations prepared for taxation purposes are outside of the scope of the Conceptual
Framework.

Note: The topic on Conceptual Framework for Financial Reporting will be thoroughly discussed in your CFAS
subject

*** END of LESSON 2***

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REFERENCES

Textbooks

1. Ballada, W. (2019). Basic Financial Accounting and Reporting. Manila: DomDane Publishers.
2. Cabrera, E.(2017) Fundamentals of Accounting Volume I, GIC Enterprises & Co., Inc., Manila
3. Millan, Z. V. (2020). Financial Accounting and Reporting (Fundamentals). Baguio City: Bandolin
Enterprise.
4. Valencia, E. and Roxas, G. (2017), Basic Accounting, Valencia Educational Supply
5. Valix, C. and Peralta, J. (2018). Financial Accounting Volume I GIC Enterprises & Co., Inc., Manila

Online Reference

1. Introduction to accounting, https://courses.lumenlearning.com/sac-finaccounting/chapter/chapter-1/

2. Accounting Basic https://www.accountingcoach.com/accounting-basics/explanation
3. Basic Accounting. https://www.bizfilings.com/toolkit/research-topics/finance/basic-accounting/the-
accounting-system-and-accounting-basics
4. Basic accounting and bookkeeping lessons, http://www.moneyinstructor.com/accounting.asp
5. Financial Accounting. https://www.accountingcoach.com/financial-accounting/explanation
6. Accounting Tutorials for Beginners. https://www.guru99.com/accounting.html

Learning Materials

1. Worksheets (teacher-made)

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