LEARNING MODULE #3

FINANCIAL ACCOUNTING AND REPORTING

By: Conrado B. Bangibang, LPT, MBA, MAED

Chapter 2 – Accounting Concepts and Principles

Learning Objectives
1. Explain the various accounting concepts and principles.
2. Solve exercises on accounting principles as applied in various cases

Introduction

Accounting concepts and principles (assumptions or postulates) are of logical ideas and
procedures that guide the accountant in recording and communicating economic information.

Accounting concepts and principles provide reasonable assurance that information

communicated to users is prepared in the proper way. Accountants have proper way of recording and
communicating economic information. This is to maximize the usefulness of accounting information to
the users.

Basic Accounting Concepts

1. Separate entity concept – under this concept, the business is

viewed as a separate person, distinct from the owner(s). Only
the transactions of the business are recorded in the books of
account. The personal transactions of the business owner(s)
are not recorded.
For example, you started a business. Under the
separate entity concept, you will view your business as a
separate person. Therefore, the money you invested to the
business is now owned by the business. It is not your personal
money anymore. Also, the business owns any money that it
earns. If you take money from the business for your personal
use, it would be recorded in the book of accounts as a withdrawal of your investment from the
business.
The application of the separate entity concept is necessary so that the financial position
and performance of the business can be measured properly. By applying the separate entity
concept, you can objectively know if the business is really earning profits, or if it has the ability
to do so.
2. Historical cost concept (Cost principle) – under this concept, assets are
initially recorded at their acquisition cost. Example, When a company
purchases a laptop, it should be recorded at the price it was purchased.

3. Going concern assumption – under this concept, the business is assumed to

continue to exist for An indefinite period of time. This is necessary for
accounting measurements to be meaningful. For example, measuring assets
at historical cost (historical cost concept) is appropriate only when the
business is a going concern.

4. Matching (or Association of cause and effect) – under this concept, some costs
are initially recognized as assets and charged as expenses only when the
related revenue is recognized.

5. Accrual Basis of accounting – under the accrual basis of accounting, economic

events are recorded in the period in which they occur rather than at the point in
time when they affect cash.

Thus, income is recorded in the period when it is earned rather than

when collected, while expenses is recognized in the period when it is incurred
rather than when it is paid. Example: When a barber finishes performing
his services, he should record it as revenue. When the barber shop receives
an electricity bill, it should record it as an expense even if it is unpaid

6. Prudence (or Conservatism) – under this concept, the accountant observes some degree of
caution when exercising judgment needed in making accounting estimates
under conditions of uncertainty. Such that, if the accountant needs to
choose between potentially unfavorable outcomes versus a potentially
favorable outcome, the accountant chooses the unfavorable one. This is
necessary so that assets or income are not overstated and liabilities or
expenses are not understated. Example: In case of doubt, expenses
should be recorded at a higher amount. Revenue should be recorded at
a lower amount.
7. Time period (Periodicity or Accounting period concept) under this concept,
the life of the business is divided into series of reporting periods. Thus,
instead of waiting until the life of the business ends before profit is
determined, the life of the business is divided into a series of equal shorts
periods called reporting periods or accounting periods.
A reporting period is usually 12 months, although it can be longer or
shorter. A 12 month accounting period is either a calendar year or fiscal year
period. A calendar year period starts on January 1 and ends December 31 of
the same year. Eg., January 1, 2020-December 31, 2020. A fiscal year period
also covers 12 months but starts on a date other than January 1, eg., June 1, 2020 to May 31,
2021.
An accounting period that is shorter than 12 months is called an “interim period.” An
interim period can be a month, a quarter (3 months) or a semiannual period (6 month).

8. Stable monetary unit – under this concept, assets, liabilities, equity,

income and expenses are stated in terms of common unit of measure,
which is the peso in the Philippines. Moreover, the purchasing power of
the peso is regarded as stable. Therefore, changes in the purchasing
power of the peso due to inflation are ignored.

9. Materiality concept – this concept guides the accountant when applying accounting principles.
This is because accounting principles are applicable only to material items.
An item is considered material if its omission or misstatement could influence economic
decisions. Materiality is a matter of professional judgment and is based on the size and nature of
an item being judged.
In case of assets that are immaterial to make a
difference in the financial statements, the company
should instead record it as an expense. For example, a
school purchased an eraser with an estimated useful life
of three years. Since an eraser is immaterial relative to
assets, it should be recorded as an expense.

10. Cost-benefit (Cost constraint) – under this concept, the cost of processing and communicating
information should not exceed the benefits to be derived from it.

11. Full disclosure principle – this concept is related to both the

concepts of materiality and cost-benefit. Under the full disclosure
 principle, information communicated to users reflects a series of judgment trade-off. The
company should report all relevant information.

12. Consistency concept – under this concept, a business shall apply accounting policies
consistently, and present information consistently, from one period to another.
Accounting policies used this year shall be the same accounting policies used last year.
This, however, does not mean that a business cannot change its accounting policies. Accounting
During
policies can the year, youif started
be changed a business
it is required by aofstandard
selling personalized mugs
or the change andresult
would T-shirts. You
in more
opened
relevant and more reliable information. Any change in accounting policy must be disclosed. of
a separate bank account for the business and deposited your initial investment
250,000.00
Application toBasic
of the this account. (Separate
Accounting Conceptsentity concept)

The business acquired a printing machine. The regular selling price is 100,000.00;
however, you were able to acquire it at a discounted price of 90,000.00. you will record the
machine at its acquisition cost of 90,000.00 rather than at the regular selling price. (Historical cost
concept)

The business acquired initial inventory of mugs and T-shirt for a total cost of 50,000.00.
you will record the cost as an asset (ie., Inventory) rather than expenses. (Matching concept)

All the inventory was sold on credit for 300,000.00 (sold on credit means pinautang in Filipino)
You will immediately record the credit sales as account receivable rather than waiting for them to
be collected. (accounts receivable means listahan ng mga pinautang in Filipino). (Accrual basis)

Also, you will now record the 50,000.00 cost of inventory as expense (Matching concept)

You collected 290,000.00 out of 300,000.00 total credit sales. You will deposit the
collections to the bank account of the business rather than to your personal account ( Separate
entity concept)

The debtor for the remaining 10,000.00 is in financial difficulty (debtor means taong umutang in
Filipino). This has raised doubt on whether he can pay his account. You will immediately recognize
the doubtful account as expense. (Prudence or Conservatism and Accrual basis)

You withdrew cash of 80,000.00 from the business for your personal use. You will record
this transaction as a withdrawal of your investment from the business rather than a business
expense. (Separate entity concept)

At the end of the year, you prepared the financial statements of your business to
determine (among other things) whether the business has earned profit. (Time Period)
 When preparing the financial statements, you discovered that the business has 10 dollars. You
will translate this to Philippine peso using the current exchange rate. The amount that you will report in
the financial statement is the translated amount. (Stable monetary unit).

Also, you found out that the regular selling price of a new printing machine increased from
100,000.00 to 120,000.00. you will ignore this information (Stable monetary unit) and will report the
printing machine at its acquisition cost of 90,000.00 in the financial statements (Historical cost). This is
because you don’t intend or expect to close the business in the foreseeable time (Going concern).

During the year, the business bought a trash bin for 80.00. you expect to use this over several
years. However, because you deemed the cost as immaterial, you will record this as an expense rather
than an asset. (Materiality).

Moreover, when you prepared the financial statements, you decided to include the cost of the
trash bin in a “Miscellaneous Expense” account together with other immaterial expenses. You don’t
expect users of the financial statements to benefit from reporting the immaterial cost separately. ( Cost-
benefit)

You will make a brief description of the “Miscellaneous Expenses” account in the notes to
financial statements, sufficient for users to understand the nature of this account. (Full disclosure)

You then adopted an accounting policy of expensing outright all acquisitions of equipment
costing 5,000.00 and below. You will apply this policy consistently in the future periods. (Consistently)

Accounting Standards

Accounting concepts and principles are either explicit or implicit. Explicit concepts and
principles are those that are specifically mentioned in the Conceptual Framework for Financial
Reporting and in the Philippine Financial Reporting Standards (PFRSs). Implicit concepts and
principles are those that are not specifically mentioned in the foregoing but are customarily
used because their general and longtime acceptance within the accountancy profession.

The terms “concepts,” “principles,” “standards,” “assumptions,” and “postulates” are

used to specifically refer to the Philippine Financial Reporting Standards (PFRSs). Traditionally
accounting standards were referred to as the generally accepted accounting procedures
(GAAP).
The Philippine Financial Reporting Standards (PFRSs) are Standard and interpretations adopted
by the Financial Reporting Standard Council (FRSC). They consist of the following:

a. Philippine Financial Reporting Standards (PFRSs)

b. Philippine Accounting Standards (PASs) and

c. Interpretations

Just like the basic accounting concepts, the standards serve as a guide when recording and
communicating accounting information. The difference is that the standards provide a more
detailed application of concepts. They also prescribe which principle is most appropriate for
specific transactions.

You may think of difference between basic concepts and standard this way – a basic
concept would be like “you need to brush your teeth three times a day”. On the other hand, a
standard would prescribe a proper way of brushing your teeth. It may even suggest a proper
way of brushing your teeth or even prescribe a certain toothbrush that is best for you.

The PFRSs are issued by the Financial Reporting Standards Council (FRSC), which is the
official accounting standard setting body in the Philippines.

The PFRSs are patterned from the International Financial Reporting Standards (IFRSs) which
are issued by the International Accounting Standards Boards (IASB). This means that the
accounting standards used in the Philippines are similar to those used in other countries.

But why do we need to have uniform accounting standards? Well, this is because, for
financial statements to be useful, they must prepared using reporting standards that are
generally acceptable. Otherwise, each business would have to develop its own standards. If that
is the case, every business may just present any asset or income it wants and omit any liability
or expense it does not want to present. Financial statements would not be comparable, the risk
of fraudulent reporting is heightened, and economic decisions based on these financial
statements would be grossly incorrect. For this reason, entities should follow a uniform set of
reporting standards when preparing and presenting financial statements.

Imagine a basketball game with no rules – the players would be like a bunch of monkeys
jumping and running around; or a society with no laws-everything would be in chaos.

Relevant Regulatory Bodies

1. Securities and Exchange Commission (SEC) – the Sec is tasked with regulating
corporations, including partnership. The SEC requires corporations and partnerships to
file audited financial statements.
2. Bureau of Internal Revenue (BIR) – the BIR is tasked in collecting national taxes and
administering the provisions of the tax code.

3. Bangko Sentral ng Pilipinas (BSP) – the BSP is tasked in regulating banks and other
entities performing banking functions.

4. Cooperative Development Authority (CDA) – the CDA is tasked in regulating

cooperatives. The CDA influences the selection and application of accounting policies by
cooperatives.