CHAPTER 2- ACCOUNTING CONCEPTS AND PRINCIPLES

LEARNING OBJECTIVES:

At the end of this chapter, the student should be able to:

1. Define Accounting Concepts and Principles

2. Explain the different Basic Accounting Concepts

3. Enumerate and explain the various Qualitative Characteristics of Financial Statements

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DEFINITION OF ACCOUNTING CONCEPTS AND PRINCIPLES

Set of logical ideas and procedures that guide the accountant in recording and communicating
economic information. They provide a general framework by which accounting practice can be
evaluated and they serve as guide in development of new practices and procedures.

BASIC ACCOUNTING CONCEPTS

1. Separate Entity Concept- the business is viewed as as a separate person, distinct from its
owners. Only the transactions of the business are recorded in the books of accounts. The
personal transactions of the business owner(s) are not recorded

the application of the separate entity concept is necessary so that the financial position and
financial performance of a 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 Concept Principle- Under this concept, assets are initially recorded at their
acquisition cost.

3. Going Concern- it means that the accounting entity is viewed as continuing in operation
indefinitely in the absence of evidence to the contrary.

It is also known as continuity assumption

In other words, financial statements are prepared normally on the assumption that the
entity shall continue in operation for the foreseeable future.

The opposite of going concern is Liquidating Concern. If the business intends to end its
operations or if it has no other choice but to do so

4. Matching Concept- under this concept, some costs are initially recorded as assets and
charged as expenses only when the related revenue is recognized.

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 5. Accrual basis of Accounting- PAS 1 requires that an entity prepares its financial statements,
except for cash flow information, using the 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 recognized in the period when it is earned rather than when it is collected,
while expense is recognized in the period when it is incurred rather than when it is paid.

6. Time Period- It requires that the indefinite life of an entity is subdivided into time periods or
accounting periods which are usually of equal length for the purpose of preparing financial
reports on financial position, financial performance and cash flows.

The accounting period may be a calendar year or a natural business year (fiscal year)

A calendar year is a twelve month period that starts on January 1 and ends on December 31.

A natural year or fiscal year is a twelve month period that starts on a date other than
January 1 and ends on any month.

An accounting period that is shorter than 12 months is called an “Interim Period” an interim
period can be a month or quarter (3 months) or a semiannual period (6 months).

7. Stable Monetary Unit- the monetary unit assumption has two aspects, namely Quantifiability
and stability of the peso,

The Quantifiability aspect means that the assets, liabilities, equity, income and expenses
should be stated in terms of a unit of measure which is the peso in the Philippines

The stability of the peso assumption means that the purchasing power of the peso is stable
or constant and that its instability is insignificant and therefore may be ignored.

8. Materiality and Aggregation- 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.

The relevance of information is being affected by its nature and materiality

Materiality of an item depends on relative size rather than absolute size, what is material
for one entity may be immaterial for another.

Very often, materiality is dependent on good judgment, professional expertise and common
sense.

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 9. Cost- Benefit (Cost Constraint)- under this concept, the costs of processing and
communication information should not exceed the benefits to be derived from the
information’s use.

10. Full Disclosure Principle- the concept is related to both the concepts of materiality and cost-
benefit. Under the full disclosure principle, information communicated to users reflect a
series of judgmental trade-offs that strive for:

a. Sufficient detail to disclose matters that make a difference to users

b. Sufficient condensation to make the information understandable, keeping in mind the

costs of preparing and using it.

QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS

Definition of Qualitative Characteristics

Are the qualities or attributes that make financial accounting information useful to the users

In deciding which information should be included in financial statements, the objective is to ensure
that the information is useful to the users in making economic decisions.

Qualitative Characteristics are classified into:

a. Fundamental Qualitative Characteristics

b. Enhancing Qualitative Characteristics

Fundamental Qualitative Characteristics

Characteristics that relate to the content or substance of financial information

The fundamental qualitative characteristics are Relevance and Faithful Representation

Information must be both relevant and faithfully represented if it is to be useful.

a. Relevance

It means the capacity of information to make a difference in a decision made by users

Relevance is the capacity of the information to influence a decision

Relevance requires that the financial information should be related or pertinent tp

economic decision

Information does not bear on an economic decision is useless.

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 Major Ingredients of Relevance

The ingredients of relevance are predictive value and confirmatory value.

Information has predictive value when it can help users increase the likelihood of correctly
predicting or forecasting outcome of events.

Example: information about financial position and financial performance is frequently used
in predicting dividend and wage payments and the ability of the entity to meet maturing
commitments.

Financial information has confirmatory value if it provides feedback about previous

evaluations. In other words, financial information has confirmatory value when it enables
users to confirm or correct earlier expectations.

Example: a net income measure has confirmatory value if it can help shareholders confirm
or revise their expectation about an entity’s ability to generate earnings.

The predictive and confirmatory roles of information are interrelated.

b. Faithful Representation

Under the conceptual framework for financial reporting, the term faithful representation is
used instead of the term reliability.

Faithful Representation means that the financial reports represent economic phenomena or
transactions in words and numbers. The descriptions and figures match what really existed
or happened.

Simply stated, faithful representation means that the actual effects of the transactions shall
be properly accounted for and reported in the financial statements.

Ingredients of Faithful Representation

B.1 Completeness

It requires the relevant information should be presented in a way that facilitates

understanding and avoids erroneous implication.

Completeness is the result of adequate disclosure standard or the principle of full disclosure

The standard of adequate disclosure means that all significant and relevant information
leading to the preparation of financial statements shall be clearly reported.

To be complete, the financial statements shall be accompanied by Notes to Financial

Statements.

The purpose of the notes is to provide the necessary disclosures required by Philippine
Financial Reporting Standards.

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 B.2 Neutrality

It means that the financial statements should not be prepared so as to favour one party to
the detriment of another party

To be neutral, the information contained in the financial statements must be free from bias.

Neutrality is synonymous with the all- encompassing “Principle of Fairness”. To be neutral

is to be fair.

The information is directed to the common needs of many users and not to the particular
needs of specific users.

B.3 Free from Error

It means there are no errors or omissions in the description of the phenomenon and the
process used to produce the reported information has been selected and applied with no
errors in the process.

In this context, free from error does not mean perfectly accurate in all respects.

Enhancing Qualitative Characteristics

Intended to increase the usefulness of the financial information that is relevant and faithfully
represented.

The enhancing qualitative characteristics relate to the presentation or form of financial statements

a. Understandability

Requires that financial information must be comprehensible or intelligible if it is to be

useful

The information should be presented in a form and expressed in terminology that a user
understands

Classifying, characterizing and presenting information “clearly and concisely” make it

understandable.

Financial reports are prepared for users who have a reasonable knowledge of business and
economic activities and who review and analyse the information diligently.

b. Comparability

It means the ability to bring together for the purpose of noting points of likeness and
difference.

It enables users to identify and understand similarities and dissimilarities among items.

Comparability may be made within an entity or between and across entities.

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 Comparability within an entity- it is the quality of information that allows comparisons
within a single entity through time or from one accounting period to the next.

Comparability within an entity is also known as Horizontal Comparability or

Intracomparability

Comparability across entities it is the quality of information that allows comparison

between two or more entities engaged in the same industry.

This comparability is also known as intercomparability or dimensional comparability

The financial statements of different entities are compared in order to evaluate their
relative financial position, financial performance and cash flows.

c. Verifiability

It means that different knowledgeable and independent observers could reach consensus
that a particular depiction is a faithful representation.

The information is verifiable in the sense that is supported by evidence so that an

accountant that would look into the same evidence would arrive at the same decision or
conclusion.

d. Timeliness

It means having information available to decision makers in time to influence their

decisions.

Timeliness requires that financial information must be available or communicated early

enough when a decision is to be made.

Relevant information may lose relevance if there is undue delay in the reporting.

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REFERENCES:

Agamata, Franklin T & Berbano Alfred. (2018) . Fundamentals of Accounting. Manila ,

Philippines: Education_Online, Inc.

Arenas T, Chua, M. & Villarina F. (2018). Fundamentals of Accounting Principles. Quezon

City: National Book Store

Covid 19 Project for Accountants: Basic Concepts –Presentation of Financial Statements

(PAS 1)

Kieso, Donald E., Kimmel Paul & Weygandt, Jerry J. (2015). Accounting Principles. USA:
Courier Kendallville

Millan, Zeus Vernon. (2019). Financial Accounting and Reporting. Baguio City: Bandolin
Enterprise

Roxas, Gregorio, F. & Valencia Edwin G. (2018). Basic Accounting. Baguio City: Valencia
Educational Supply

Tolentino, Gloria J. & Lupisan Ma. Concepcion Y. (2017). Accounting for Partnership and
Corporation. Manila: Millenium Books, Inc.

Valix Conrado T & Valix Christian Aris M. (2018). Theory Financial Accounting. Manila: GIC
Enterprises & Co. Inc.

Vera Cruz- Manuel, Z. (2018). 21st Century Accounting Process 16th Edition. Quezon City:
Raintree Trading & Publishing Inc.

The harder you work for something, the greater you’ll feel when you achieve it.

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