Professional Documents
Culture Documents
1 – Conceptual Framework:
Need for generally accepted accounting principles (GAAP) as basis for preparation and presentation of
financial statements:
The conceptual framework is actually a set of concepts, principles and rules in the preparation and
presentation of “general-purpose financial statements.” Since the financial statements are general-purpose, it
means that they are intended for the use of all kinds of users (e.g. investors, shareholders, creditors, suppliers,
customers, government, etc.). As such, the financial statements should be prepared in accordance with the
generally accepted accounting principles in order to ensure fair presentation of information contained in the
financial statements. In addition, GAAP ensures the neutrality of financial statement which means no group of
users is favoured to the detriment of other groups of users. A deviation from GAAP will render the financial
statements unreliable. A good example would be Enron Corp., which in 2001, used creative accounting rules to
overstate earnings and hide billions of debt. Consequently, Enron’s CEO, Jeff Skillings, was convicted of fraud
and sentence to a 24-year sentence. The auditing firm of Arthur Anderson, Enron’s external auditors, was
dissolved. The financial scandal led to Enron Corp.’s bankruptcy.
Sources of GAAP:
The Financial Reporting Standards Council (FRSC) has been created by the Professional Regulation
Commission (PRC) upon the recommendation of the Board of Accountancy (BOA) to establish and improve
accounting standards which will be generally accepted in the Philippines. The accounting standards are issued
by the FRSC through:
A. Philippine Financial Reporting Standards (PFRS)
B. Philippine Accounting Standards (PAS)
C. Rules and guidelines on gray accounting issues as interpreted by the Philippine Interpretation
Committee (PIC)
These are the standards and rules which are applied din the preparation and presentation of financial
statements. However, it should be pointed out that in formulating these accounting standards, the FRSC has
used as basis the conceptual framework. The conceptual framework can be applied only if there is no PFRS or
PAS that covers an accounting issue.
SPECIFIC METHODS
AND PROCEDURES
PRINCIPLES
ASSUMPTIONS
As shown in Figure A, accounting theory starts with the accounting assumptions. The accounting
assumptions support the accounting principles and the accounting principles, in turn, support the specific
methods and procedures adopted in recording transactions to the eventual preparation of financial statements.
By way of illustration, assume a business entity purchased equipment with an estimated useful life of 5
years for P1,000,000 on Jan. 1, 2020. This transaction is recorded by debiting an asset account “Equipment”
and crediting “Cash.” Assuming the calendar year is sued as the accounting period, the business entity
prepared an adjusting entry on Dec. 31, 2020 by debiting “Depreciation Expense” and crediting “Accumulated
Depreciation-Equipment.” An asset is recognized on Jan. 1, 2020, in accordance with the asset recognition
principle because it is probable that future economic benefits will flow into the entity through the use of the
equipment. The amount recognized as an asset is P1,000,000 because this is in accordance with the cost
principle which requires that assets be recorded at original acquisition cost. The P1,000,000 cost is also in
accordance with the qualitative characteristic of “Faithful Representation” which states that the actual effects of
the transaction shall be accounted for. The cost principle in turn rests on the accounting assumption of “Going
Concern” and “Monetary Unit.” The equipment is estimated to be used from Jan. 1, 2020 to Dec. 31, 2024
which assumes that the business entity will still be in operation in the future. Under the “Going Concern
Assumption,” the business entity is assumed to operate indefinitely into the future unless there is evidence to
the contrary [1]. The quantifiability aspect of monetary unit assumption, on the other hand, requires that
accounting elements be recorded in terms of a common unit of measure which is the peso in the Philippines.
The preparation of an adjusting entry on Dec. 31, 2020 is in accordance with the “time period assumption”
which states that a business entity’s useful life is divided into shorter periods of time which is normally one year.
Therefore, financial statements are prepared every year which necessitated preparation of adjusting entries to
take up unrecorded income and expenses. Finally, the P1,000,000 cost of the equipment is allocated over 5
years as P200,000 depreciation expense annually in accordance with “systematic and rational allocation” of
the expense recognition principle.
[1] This is also the reason why the basis for measurement of the equipment is cost rather than other bases of
measurement such as market value or net realizable value; the reason is that the business entity is not going
to undergo liquidation and market value is therefore not relevant.