FINANCIAL ACCOUNTING AND REPORTING

LEARNING MODULES

Lesson 2 ACCOUNTING CONCEPTS AND PRINCIPLES

Did you know that?

LEARNING OBJECTIVE Washington Z. Sycip became the first Asian and the
only Filipino president of the International Federation
1. Apply the accounting concepts and of Accountants in 1982 until 1985.
principles in real-life situations. Source: www.ifac.org

Accounting concepts and principles guide accountants in

recording and communicating economic information. These concepts and principles are either explicit or implicit.
Those that are specifically mentioned in the Conceptual Framework for Financial Reporting and the Philippine
Financial Reporting Standards (PFRS) are called explicit concepts and principles while those that are not mentioned
are called implicit concepts and principles. Accounting standards refer to the PFRS and previously called generally
accepted accounting principles (GAAP). Technically, the standards and interpretations adopted by the Financial
Reporting Standard Council, the official accounting standard-setting body in the Philippines, include the (1)
Philippine Financial Reporting Standards, (2) Philippine Accounting Standards, and (3) Interpretations.

Basic Assumptions and Principles in Financial Reporting

Monetary Unit Economic Entity Time Period Going Concern
The monetary unit The economic entity The time period The going concern
assumption requires that assumption states that assumption states that assumption states that
only those things that can every economic entity can the life of a business can the business will remain in
be expressed in money be separately identified be divided into artificial operation for the
are included in the and accounted for. It is time periods and that foreseeable future. It is
accounting records. It is also called separate entity useful reports covering also called continuity
also called monetary unit concept, accounting entity those periods can be assumption.
concept and stable concept, entity concept, prepared for the business.
monetary unit concept. It and business entity It is also called periodicity This assumption underlies
follows the quantifiability concept. concept, accounting the historical cost
assumption (common unit period concept, and principle that dictates
of measurement) and reporting period concept. that companies record
peso stability assumption assets at their cost in
(stable value of money). This assumption supports adherence to the
the accrual-basis objectivity principle in
A reporting period or accounting period is usually 12 accounting in which which the purchase price
months, although it can be longer or shorter income is recorded in the as indicated in the
depending on the normal accounting cycle of the period when it is earned document must be used
business. It can be a calendar year period (January 1 rather than when it is as the value of the asset.
to December 31 of the same year) or a fiscal year collected (revenue
period (12 months and may start other than January
recognition principle) If the business intends to
1). An accounting period that is shorter than 12
while expense is recorded liquidate, it becomes a
months is called an interim period that can be a
month, a quarter (3 months), or semi-annual (6 in the period when it is liquidating concern. Then,
months). incurred upon which the it follows the fair value
related revenue is principle in which assets
generated rather than and liabilities should be
An economic entity can be any organization or unit when it is paid (expense reported at fair value (the
in society. It may be a company, a government recognition principle, also price received to sell an
agency, a municipality, a school district, or a church. known, as matching asset or settle a liability).
principle)

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Companies should consider the cost constraint or cost-benefit principle in which the benefit must outweigh the
cost in providing information to the users. Moreover, when a company needs to choose between a potentially
favorable from the unfavorable outcome, the unfavorable one should be chosen. This is in adherence to the
principle of prudence or conservatism which prescribes the observance of some degree of caution when
exercising judgments under conditions of uncertainty. In this manner, assets or income are not overstated and
liabilities or expenses are not understated.

These are called fundamental qualities because it makes the information useful to users.
Relevance
Accounting information has relevance if it would make
a difference in a business decision. The relevant
information has the following aspects:
a. It has predictive value if it helps in making
predictions.
b. It has confirmatory value if it confirms or corrects
past predictions.
c. Materiality is a company-specific aspect of relevance.
An item is material when its size makes it likely to
influence the decision of an investor or creditor.
Faithful Representation
Faithful representation means that information
accurately depicts what happened. Faithfully
represented information has the following aspects:
a. Information is complete if all necessary information is
provided. It supports the full-disclosure principle that
requires companies to disclose all circumstances and
events that would make a difference to financial
statement users.
b. Information is neutral if it is not biased toward one
position or another.
c. The information must be free from error particularly
in describing and processing accounting information.

These are called enhancing qualities because it enhances the usefulness of the information.
Comparability Verifiability Timeliness Understandability
Different companies use Information is verifiable if The information must be The information must be
the same accounting independent observers, timely available to clear and concise so that
principles. using the same methods, decision-makers before it users who have
obtain similar results. This loses its capacity to reasonable knowledge
The company uses the supports the objectivity influence decisions. and willingness to analyze
same accounting principle. can interpret it and
principles and methods comprehend its meaning.
from year to year which is
known as the consistency
principle.

Let us consider what accounting assumption, concept, or principle that relates to the story.
1
In the time of the opening of the school, you started an Economic entity assumption. The business must be separated
internet café business and invested P100,000 as initial capital from the owner.
and deposited in a bank account named after the business1.
2
The business acquired computers amounting to P50,000 of Historical cost principle. The computer should be recorded at
which P1,000 was deducted as a trade discount and recorded acquisition cost.
P49,0002 as evidenced in the official receipt 3 provided by the 3
Objectivity principle. Each transaction should have a source
supplier. document as evidence.
4
The business acquired supplies amounting to P3,000 and was Matching principle. Expense is recognized when the related
recorded as prepaid supplies4 instead of supplies expense. revenue is generated.
5
The business rendered services to various clients on credit Accrual-basis accounting. Income is recognized when earned
amounting to P5,000 and recorded as accounts receivable5. regardless of when received.
6
The owner estimated that P100 will not be collected because Prudence or Conservatism. Expense should be overstated
the debtor is nowhere to be found and immediately recorded rather than understated.
as bad debts expense6.
7
The owner withdrew cash from the business amounting to Economic entity assumption. Personal withdrawal should be a
P2,000 and recorded as drawings7. withdrawal of investment.
When the year ended8, the business prepares the financial 8
Time period assumption. The life of the business is divided
statements to determine the profit of the business. into reporting periods to determine the profit of the business.
9
The business discovered that there is a $20 US dollars paid by Monetary unit assumption. Financial statements should be
a client. The accountant translated9 the dollar into the presented using a common unit of measurement.
Philippine peso using the current exchange rate.
10
Despite the COVID-19 pandemic which is mostly affected Going concern assumption. Businesses are expected to
across all business sectors, the owner still expects that the operate indefinitely.
internet café business will continue to operate indefinitely 10.

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11
The owner bought broomsticks for the café amounting to P50 Materiality concept. The business can decide when a
which will be expected to be used for less than a year. So, the transaction is considered to be material or not depending on the
owner recorded such as an expense instead of an asset 11. company’s policy.
12
However, the accountant describes other expenses with Full disclosure principle. The financial statements should
complete details in the notes to financial statements 12. disclose all the necessary information to make it more
understandable to the users.
13
The business recorded all immaterial expenses as other Cost-benefit constraint. The user should gain more benefit
expenses since the business considered this policy as more than its cost in providing accounting information.
beneficial to the user than recording each separately13.
This particular policy was consistently 14 applied yearly by the 14
Consistency principle. The same accounting policy was
company. applied from year to year.
15
During the following year, the business rendered internet Revenue recognition principle. Revenue is recognized on the
services on January 16 and received payment on January 18. date when it is earned.
The business recorded an income on January 1615.
16
The business requested for repair services from an IT Expense recognition principle. Expense is recognized on the
technician and rendered the service on February 1 16. The date when it is incurred.
business paid the technician on February 15. However, the
business recorded the expense on February 1.

This time, let us check the following transactions in which accounting assumption, concept, or principle has been
violated.

1. The accountant included sales of the subsequent period
as sales of the current period.
2. The owner bought a new computer for personal use and
was charged to the business as expenses.
3. Equipment costing P50,000 was reported at P30,000 in its
current market value.
4. The owner did not report the portion of receivables
pledged to obtain a bank loan.
5. The owner decided not to report depreciation incurred
this year because it can lower the net income.
6. The accountant records transactions as desired by the
owner without proper supporting documents.
7. The accounting methods and procedures used are
changed regularly every six months.
8. The financial reports are always delayed.
9. The company depreciated a calculator costing P60
because it is estimated to be used for five years.
10. A company believes that it will close its operations in the
next five years.
Revenue recognition principle. Sales should be recognized
during the period when it was earned.
Economic entity assumption. Personal transactions must be
distinct from the business.
Historical cost principle. Assets should be recorded at its
acquisition cost.
Full disclosure principle. Financial statements should disclose
all the necessary information to the users.
Expense recognition principle. Expenses should be recognized
when the related income is earned.
Objectivity principle. Transactions must be supported with
proper documents.
Consistency principle. Accounting methods and procedures
must be consistently applied from year to year.
Timeliness. Financial statements should be made timely to
ensure its relevance.
Materiality concept. When things are immaterial, it should be
expensed outright rather than recording it as an asset and
depreciate it eventually.
Going concern assumption. Businesses are expected to operate
indefinitely.

Suggested Readings

1. Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp. 43-58.
2. Conceptual Framework and Accounting Standards (2019) by Millan, pp. 37-52.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition.
Manila, Philippines: DomDane Publishers.
2. International Federation of Accountants. (2007). IFAC: 30 Years of Progress Encouraging
Quality and Building Trust https://www.ifac.org/system/files/downloads/IFAC_History_-_
Nov_2007.pdf.
3. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio
City, Philippines: Bandolin Enterprise.

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4. Philippine Institute of Certified Public Accountants - Northern Metro Manila Chapter.

(2018). PFRS.
5. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition.
Asia: John Wiley & Sons (Asia) Pte Ltd.