Government Property Senior High School

NOT FOR SALE

Fundamentals of
Accountancy, Business and
Management 1
Quarter 3 - Module 2:
Lesson 1&2
Accounting Concepts and Principles

Department of Education  Republic of the Philippines

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What Is It

Guidelines on Basic Accounting

Principles and Concepts

Generally Accepted Accounting

Principles (GAAP) is the Framework and
guidelines of accounting profession. Its
purpose is to standard accounting
concepts, principles and procedures.

Basic accounting principles and concepts:

Business entity principle

A business enterprise is separate and distinct from its owner or investor. Any
personal transactions of its owner should not be recorded in the business accounting
book unless the owner's personal transaction involves adding and/or withdrawing
resources from the business.

Examples:
⚫ If the owner has a barber shop, the cash of the barber shop should be reported
separately from personal cash.

⚫ The owner had a business meeting with a prospective client. The expenses that
come with that meeting should be part of the company's expenses. If the owner
paid for gas for his personal use, it should not be included as part of the
company's expenses.

Going concern principle

A business is expected to continue indefinitely. On this basis, generally, assets are
recorded based on their original cost and not on market value. Assets are assumed to
be held and used for an indefinite period of time or during its estimated useful life.
Those assets are not intended to be sold immediately or liquidated.

Examples:

Possible losses from the closure of business cannot be anticipated in the accounts.

Prepayments, depreciation provisions may be carried forward in the expectation of

proper matching against the revenues of future periods.Fixed assets are recorded at
historical cost.

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Time period principle
Financial statements are to be divided into specific time intervals.

Examples:
⚫ Philippine companies are required to report financial statements annually.
⚫ The salary expenses from January to December 2015 should only be reported
in 2015.

Monetary unit principle

– are amounts stated into a single monetary unit.
The business financial transactions recorded and
reported should be in the monetary unit, such as
Philippine Pesos, US Dollar, Euro, etc. Thus, any
non-financial or non-monetary information that cannot be
measured in a monetary units are not recorded in the
accounting books, but instead, a memorandum will be
used.
Examples:
⚫ Jollibee should report financial statements in pesos even if they have a store in
the United States.
⚫ IHOP should report financial statements in dollars even if they have a branch
here in the Philippines

Historical Cost
All business resources acquired should be valued and recorded based on the
actual cash equivalent or original cost of acquisition, not the prevailing market value or
future value. The exception to the rule is when the business is in the process of closure
and liquidation.

Example:
The cost of fixed assets is recorded at the date of acquisition cost. The acquisition cost
includes all expenditure made to prepare the asset for its intended use. It includes the
invoice price of the assets, freight charges, insurance, and installation cost of any.

Matching principle
Cost should be matched with the revenue generated. This principle requires that
revenue recorded, in a given accounting period, should have an equivalent expense
recorded, in order to show the true profit of the business.

Examples:
⚫ Recording of doubtful account expense should be done when the revenue was
earned.
⚫ Advanced payment from clients must be recorded in the month when the
services were rendered.
⚫ Expenses incurred in generating revenues should be recorded at the time when
revenue was earned
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Accounting Period
This principle entails a business to complete the whole accounting process over a
specific operating time period. Accounting period may be monthly, quarterly or
annually. For annual accounting period, it may follow a Calendar or Fiscal Year.

Example:

The owner can monitor the results of the business operations periodically either
monthly, quarterly, or annually to check whether it is profitable or not.

Conservatism principle
It is also known as prudence. In case of doubt,
assets and income should not be overstated while
liabilities and expenses should not be understated.
The principle of conservatism gives guidance on how
to record uncertain events and estimates. The
principle of conservatism states that one should
always consider an error on the most conservative
side of any transaction. This means minimizing profits
by recording uncertain losses or expenses and not
recording uncertain or estimated gains.

Example:
Assume gold guitar, Inc. is in the middle of a patent lawsuit. GGI is suing Blue Guitar,
Inc. for patent infringement and anticipates winning a large settlement. Since, the
settlement is not certain, GGI did not record the gain on the financial statements. Why?
Because GGI might not actually see this gain. It might not win, or they might not win as
much as it expected. Since a large winning settlement might skew the financial
statements and mislead the users, the gain is left off the books.

Consistency Principle
The consistency principle states that companies should use the same accounting
treatment for similar events and transactions over time.
The consistency principle does not state that business always have to use the same
accounting method forever.

Example:

Bob's Computers, a computer retailer, has historically used FIFO for valuing its
inventory. In the last few years, the business has become quite profitable and Bob’s
accountant suggests that Bob switches to the LIFO inventory system to minimize
taxable income. According to the consistency principle, Bob's Computers can change
accounting methods for a justifiable reason.Minimizing taxes as a justifiable reason is
debatable.
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Materiality principle
In case of assets that are immaterial to make a difference in the financial
statements, the company should instead record it as an expense. The materiality
concept, also called the materiality constraint, states that financial information is
material to the financial statements if it would change the opinion or view of a
reasonable person. In other words, all important financial information that would sway
the opinion of a financial statement user should be included in the financial
statements.
The concept of materiality is relative in size and importance.

Examples:

⚫ A large company has a building in the typhoon area during Yolanda Storm. The
company building is destroyed and after a lengthy battle with the insurance
company, the company reports an extraordinary loss of P10,000.00. The
company has net income of P10,000,000.00. The materiality concept states
that this loss is immaterial because the average financial statement user would
not be concerned with something that is only 1% of net income.

⚫ A school purchased an eraser with an estimated useful life of three years. Since
an eraser is immaterial relative assets, it should be recorded as an expense.

Objectivity principle
Financial statements must be presented with
supporting evidence. The objectivity principle states
that accounting information and financial reporting
should be independent and supported with unbiased
evidence. This means that accounting information
must be based on research and facts, not merely
preparer's opinion. The objectivity principle is aimed
at making financial statements more relevant and
reliable.

Example:

⚫ A company is trying to get financing for an extra plant expansion, but the
company's bank want to see a copy of its financial statements before it will
allow a loan to the company any money. The company's bookkeeper prints out
an income statement from its accounting system and mails it to the bank. Most
likely the bank will reject this financial statement because an independent party
is not the one who prepare it.In other words, this income statement violates the
objectivity principle.
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⚫ When the customers paid Jollibee for their order, Jollibee should have a copy of
the receipt to represent as evidence.
Revenue Recognition Principle
The revenue recognition principle states that revenue should be recognized and
recorded when it is realized or realizable and when it is earned.

Example:

Bob's Billiards, Inc. sells a pool table to a bar company on December 31 for
P85,000.00. The pool table was not paid for until January 15 and it was not delivered
to the bar until January 31. According to the revenue recognition principle, Bob's
should not record the sale in December. Even though the sale was realizable in that
the sale for P85,000.00 was initiated, it was not earned until January when the pool
table was delivered.
Cost principle
Anaccounts should be recorded initially
at cost.

Examples:
⚫ When Jollibee buys a cash register,
it should record the cash register at its price
when they bought it.
⚫ When a company purchases a
laptop, it should be recorded at the price it
was purchased.

Accrual Accounting Principle

Revenue should be recognized when earned regardless of collection and
expenses should be recognized when incurred regardless of payment. On the other
hand, the cash basis principle in which revenue is recorded when collected and
expenses should be recorded when paid. Cash basis is not the generally accepted
principle today.

Example:
When a barber finishes performing his services he should record it as revenue. When
the barber shop receives an electricity bill, it should be recorded as an expense even if
it is unpaid.

Disclosure principle
All relevant and material information should be reported.

Example:
The company should report all relevant information.

Qualitative Characteristics of Financial Information

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RELEVANCE
The concept of relevance implies that financial statements can have predictive
value and feedback value. This means the financial statements are accurate and can
be used to predict future company performance.
 Three main characteristics of relevant accounting information: predictive value,
feedback value, and timeless.

PREDICTIVE VALUE
Predictive value refers to the fact that quality financial information can be used
base predictions, forecast, and projections on. Financial analysts and investors can
use past financial statements to chart performance trends and make predictions about
future performance and profitability.

FEEDBACK VALUE
Quality information has a feedback value when it can confirm or correct previous
expectations. In other words, users can examine financial information and confirm or
adjust their predictions made on previous performance trends. Based on the feedback,
users can make future decisions.
TIMELESS
Timeless is one of the most important factors in relevant information. Out of date
information does not do investors or creditors any good when they are trying to make
current and future decisions. Financial reporting must be timely and current in order
to be used by investors and creditors.
RELIABILITY
The concept of reliability implies that financial information can be verified by many
source with evidence and that all financial information is presented. In other words, the
favorable and unfavorable financial information are presented in the financial
statements.

Three main attributes that all reliable financial information has: verifiability,
representational faithfulness, and neutrality.
VERIFIABILITY
Financial information is verifiable when multiple, independent measures are used
to come up with the same result.
REPRESENTATIONAL FAITHFULNESS
Representational faithfulness simply means that the financial statements
represent reality or what actually happened during the year.
NEUTRALITYFinally, in order for financial statements to be reliable they must be
neutral. By definition, financial statements that are prepared by company
management are somewhat biased because the management want to see the
company improve.
COMPARABILITY
Comparability is a quality of accounting information that addresses the usability of
financial information. Information that is prepared using the same measurement
techniques and reported in a similar and can be judged side by side other similar
financial information.
Comparability is extremely important to the end users of financial statement.
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