LESSON 1-4 A C C O UNTIN G C ONCEPTS AN D PRIN CIPLE S

Lesson O b je ctiv e s

• d e fin e g e n erally a c c e p t e d a c c o u n tin g principles (GAAP)

• know a n d a p pre cia t e th e basic a c c o u n tin g principles used in th e pra ctic e of
a cco u n tin g

GENERALLY ACCEPTED AC C OUNTING PRINCIPLES (GAAP)

• T h e s e a re bro a d , g e n e ra l s t a t e m e n ts o r “ ru l e s ” a n d “ pro c e d ure s” t h a t s erv e as
g uid e s i n th e p r a c tic e o f a c c o u n tin g .
• T h e s e a re s t a n d a rd s , a s s u m p tio n s , a n d conc e pts w i t h g e n e ra l a c c e p t a b ility .
• T h e s e are m e a s u r e m e n t t e c h n iq u e s a n d s t a n d a rd s u s e d i n th e p r e s e n t a tio n a n d
p r e p a r a tio n o f f in a n c i a l s t a t e m e n ts .

> Accounting system c o m pris e s th e m e th o d s us e d b y a b u sin e s s to k e e p re c ord s o f it s

f in a n c i a l a c tiv iti e s a n d to s u m m a ri z e th e s e a c c ou nts i n p e rio d ic a c c o u n tin g r e p o rts .
> Transaction is a c o m p le t e d a c tio n w h ic h c a n be e xpre ss e d i n m o n e t a ry t e rm s .

F und a m e nta l C oncepts

1. E ntity Concept re g a rd s th e bu sin e s s e n t e rp ris e as s e p a ra te a n d d is tin c t fro m it s

o w n e rs a n d fro m o th e r b u sin e ss e n t e rpris e s .

E x a m p le : D r. T e n g h a s a s k in c lin ic a n d a spa. T h e s k in c lin ic is consid ere d as a s e p a ra te

e n t it y d is tin c t fro m th e sp a a n d th e o w n e r, D r. T e ng. T h e e xp e ns e s o f th e s k in c lin ic
s h o u ld n o t be m ix e d w it h th e exp e nse s o f th e sp a a n d th e p e rs o n a l e xp e ns e s o f D r.
T e ng. T h e tw o busin e ss e s are c o nsid ere d to be s e p a ra te e conomic u n its , s e p a ra te a nd
d is tin c t fro m t h e ir ow n e r. A s such, th e y s h o u ld b e tr e a t e d as d iff e r e n t fro m e a ch o th e r,
a lth o u g h o w n e d a n d o p e ra t e d b y o n ly on e p erson. H e nc e , th e p e rs o n a l exp e nse s o f D r.
T e n g s h o u ld n o t be m ix e d w it h th e exp e nse s o f a n y o f th e busin e ss e s.

18 H The N a ture o f A c c o u n tin g a n d Its Business E nvironm e nt

2. P eriodicity is th e conc e pt b e h in d p ro v id in g fin a n c i a l a c c o u n tin g in fo rm a tio n a b o u t
th e e conom ic a c tiv iti e s o f a n e n t e rp ris e fo r s p e cifie d tim e p e rio d s . F o r r e p o rtin g
p urpo s e s, on e y e a r is u s u a lly c o n sid e re d as on e a c c o u n tin g p e rio d .
E x a m p l e : S e p a ra te f in a n c i a l r e p o rts are p re p a re d y e a rly f o r th e s k in c lin ic a n d th e sp a
o f D r. T e ng. H e nc e , D r. T e n g c a n m e a s ure th e in c o m e o f th e tw o busin e ss e s a n n u a lly .

A n a c c o u n tin g p e rio d m a y be c la s s ifie d as e ith e r o f th e fo llo w in g :

a. Calendar year - a tw e lv e -m o n th p e rio d t h a t s t a rts on J a n u a ry 1 a n d e nds on
D e c e m b e r 31
b. Fiscal year - a tw e lv e -m o n th p e rio d t h a t s t a rts on a n y m o n th o f th e y e a r o th e r
t h a n J a n u a ry a n d e nds tw e lv e m o n th s a ft e r th e s t a rt in g p e rio d , e.g., a b u sin e s s
w hos e fis c a l y e a r s t a rt s M a y 1, 2016 e nds it s fis c a l y e a r on A p r i l 30, 2017.
N o te : A n a t u r a l b u sin e s s y e a r is a n y tw e lv e -m o n th p e rio d t h a t e nds w h e n b u sin e s s
a c tiv iti e s a re a t t h e ir lo w e s t p o in t.

3. Going Concern is a c onc e pt w h ic h a ssum e s t h a t th e b u sin e s s e n t e rp ris e w i l l c o n tin u e

to o p e ra t e in d e fin it e ly .
E x a m p l e : I n p r e p a rin g th e f in a n c i a l s t a t e m e n ts o f th e s k in c lin ic a n d th e spa, th e
a c c o u n t a n t a ssum e s t h a t th e b u sin e ss e s w i l l n o t close or s h u t o p e ra tio n s w i t h i n th e
n e x t y e ars.

B asic A ccounting Principle s

1. O bjectivity principle st a t e s t h a t a ll b u sin e s s tra n s a c tio n s t h a t w i l l be e n t e re d in

th e a c c o u n tin g re c ord s m u s t be d u ly s u p p o rt e d b y v e rifi a b l e e vid e nc e .
E x a m p l e : P a y m e n ts m u s t be s u p p ort e d b y o ffic i a l r e c e ip ts a n d b a n k d e p o sits m u s t be
s u p p o rt e d b y d e p o s it slip s .

2. Historical cost m e a n s t h a t a ll p ro p e rti e s a n d s ervic e s a c q u ir e d b y th e b u sin e s s m u s t

be re c ord e d a t t h e ir o rig in a l a c q u is itio n cost.
E x a m p l e : L a n d b o u g h t i n 2001 fo r tw o m illio n pe sos s h o u ld be re c ord e d a t tw o m illio n
pesos e v e n th o u g h it s m a rk e t v a lu e i n th e y e a r 2016 is a lr e a d y th r e e m illio n pesos.

3. Accrual principle st a te s t h a t in c o m e s h o u ld be re cogniz e d a t th e tim e i t is e a rn e d such

as w h e n goods a re d e liv e re d o r w h e n s ervic e s h a v e b e e n re nd e re d . L ik e w is e , expe nses
s h o u ld be re cogniz e d a t th e tim e th e y are in c u rr e d , such as w h e n goods a n d s ervic e s are
a c tu a lly us e d a n d n o t a t th e tim e w h e n th e e n t it y p a ys fo r thos e goods a n d s ervic e s.
E x a m p le . A r e s o rt c a n n o t c o n sid e r as in c o m e th e a dv a nc e p a y m e n t o f a c u s to m e r w h o
p a id h is tw o-w e e k r e s o rt a c c o m m o d a tio n i n a dv a nc e u n t i l th e c u s to m e r h a s ch e ck e d
in . T h is is b e c a us e th e r e s o rt h a s n o t y e t re n d e re d th e s ervic e to th e c u s to m e r. A s
such, th e a dv a n c e p a y m e n t b y th e c u s to m e r s h o u ld b e c o n sid e re d as a li a b i li t y on th e
p a r t o f th e r e s o rt i n th e fo rm o f s ervic e s to b e re n d e re d .

A c c o u n tin g C o n c e p ts a n d Principles 19
4. Adequate disclosure st a t e s t h a t a ll m a t e ri a l f a c ts t h a t w i l l s ig n ific a n tly a ff e c t th e
f in a n c i a l s t a t e m e n ts m u s t be in d ic a t e d .
E x a m p l e : L a n d b o u g h t a t tw o m illio n pesos i n 2001 s h o u ld be re c ord e d a t h is to ric a l
cost i n th e 2016 fin a n c i a l s t a t e m e n ts . H o w e v e r, th e c u rr e n t m a rk e t v a lu e o f th r e e
m illio n pesos i n th e y e a r 2016 m a y b e in d ic a t e d i n th e fin a n c i a l s t a t e m e n ts fo r th e
y e a r 201 6 i n th e fo rm o f a fo o tn o t e or p a r e n th e tic a l note .

5. M ateriality m e a ns t h a t f in a n c i a l r e p o rtin g is o n ly c o n c e rn e d w i t h in fo rm a tio n

s ig n ific a n t e n o u g h to a ff e c t d e cisio ns. T h is r e f e rs to th e r e l a tiv e im p o rt a n c e o f a n it e m
or e v e n t. A n it e m is c o n sid e re d s ig n ific a n t i f k n o w le d g e o f i t w o u ld in flu e n c e p ru d e n t
us e rs o f th e f in a n c i a l s t a t e m e n ts .
E x a m p l e : It e m s o f in s ig n ific a n t a m o u n t such as p a p e r c lip s c a n b e c h a rg e d o u trig h t to
e xp e ns e s.

6. Consistency m e a ns t h a t a p pro a ch e s us e d i n r e p o rtin g m u s t be u n if o rm ly e m plo y e d

fro m p e rio d to p e rio d to a llo w c o m p a ris o n o f r e s u lts b e tw e e n tim e p e rio d s . A n y ch a ng e s
m u s t be c l e a rly e x p la in e d .
E x a m p l e : I f th e s tr a ig h t lin e m e th o d o f d e p re c ia tio n is b e in g u s e d b y th e c o m p a n y,
th e n th e m e th o d s h o u ld be u n if o rm ly us e d b y th e c o m p a n y i n c o m p u tin g it s a n n u a l
d e p re c ia tio n .

W h a t are g e n e r a lly a cc e pte d a c c o u n tin g p rin c ip l e s ?

Identify the concept or principle that each statement refers to.

1. T h is r e f e rs to th e r e l a tiv e im p o rt a n c e o f a n it e m or e v e nt.
A n it e m is c o n sid e re d s ig n ific a n t i f k n o w le d g e o f i t w o u ld
in flu e n c e p ru d e n t u s e rs o f th e f in a n c i a l s t a t e m e n ts .

2. E xp e ns e s s h o u ld be re c o g n iz e d a t th e tim e t h e y a re in c u rr e d
such as w h e n goods a n d s ervic e s are a c t u a lly us e d a n d n o t a t
th e tim e w h e n th e e n t it y p a ys f o r th o s e goods a n d s ervic e s.

20 T he N a ture o f A c c o u n tin g a n d Its Business E n v iro n m e n t