Accounting concepts, principles, and assumption

- Essential in the practice of accounting.

- FS become more comparable and more useful.
- Foundation in accounting to avoid misunderstanding.
- Enhance the understanding and usefulness of FS.

1. Separate Entity Concept/Accounting Entity Assumption/Business Entity Concept/Economic Entity Assumption – a

business is separate and distinct from its owners/investors. The personal transactions are separate from that
business he/she owns (Transactions of the business are recorded separately from any personal transactions.
Example:
o If the owner has a barber shop, the cash of the barber shop should be reported separately from
personal cash.
o 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.
o If you have 3 businesses - each business will have its own accounting records. It
should not be mixed with the other business.
2. Historical cost concept – accounts should be recorded initially at cost. Amounts in financial statements are
reported in historical cost. Inflation - X
Example:
o When Jollibee buys a cash register, it should record the cash register at its price when they bought it.
o When a company purchases a laptop, it should be recorded at the price it was purchased.
o PPE - Land – Cost – Php 5M vs Fair Market Value Php 6M.
3. Going Concern Assumption – business is expected to continue indefinitely until the foreseeable future and that
company closure is not imminent. As if the business will continue forever. The operations of the business will
not stop in the near future, and it will not forced to liquidate its assets to pay off its liabilities.
Evidences of not going concern:
 The results of operations consistently show losses.
 Inability to pay obligations of the company on time.
 Loan defaults
 Suppliers do not sell on credit to the company.
 Legal proceedings against the company.

Example:
o When preparing financial statements, you should assume that the entity will continue indefinitely.
4. Matching – cost should be matched with the revenue generated (expenses are recognized in the same period as
the related revenue). They should not be separated. Revenue of the business always comes with expenses. No
business can generate revenues without incurring expenses.
Example:
When you provide tutorial services to a customer and there is a transportation cost incurred related to the
tutorial services, it should be recorded as an expense for that period.
5. Accrual
Cash Accounting vs Accrual Accounting
Revenue Received Earned
Expense Paid Incurred

Example:
o In ukay-ukay business, sales can be cash or on credit. Cash (okay) Credit (use of Accounts Receivable)
 o Welder finished his job even though client did not pay yet.
o Hotel – advance payment (No) Checked in (Yes)
o 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/Conservatism – if there are alternatives in a situation choose that will result in lesser in income. Do
not count the chicks until they are hatched. In case of doubt, record any loss, and do not record any gain.
Example:
o When an accountant is unsure whether or not to recognize an expense, the concept of prudence states
that he/she should recognize it in the accounting records. On the other hand, if the accountant is unsure
whether or not to recognize income, he/she will not recognize it.
7. Time Period/Artificial time/Separate time period – financial statements are to be divided into specific time
intervals. Transactions are summarized and reported at regular intervals.
Calendar year – (January 1– December 31) Fiscal Year- (Any starting point + 12 months)
Example:
o Philippine companies are required to report financial statements annually.
o The salary expenses from January to December 2015 should only be reported in 2015.
8. Stable Monetary Unit – amounts are stated into single monetary unit. In the Philippines, we used Peso.
Example:
o Jollibee should report financial statements in pesos even if they have a store in the United States.
o IHOP should report financial statements in dollars even if they have a branch here in the Philippines
9. Materiality – If it is probable that users of the FS would have altered their actions if the information had not been
omitted/misstated, the item is considered to be material. In case assets that are immaterial to make difference in
the financial statements, the company should record it as an expense. It is based on sound judgment/estimates.
Example:
o 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.
o Warranty expense
o Big companies often round-off peso amounts when presenting financial statements
10. Cost-Benefit – Benefit should outweigh the cost. Same concept of materiality.
Cost - Benefit -

o A business purchased a small stapler. The stapler is expected to be used for a long period of time.
However, the business immediately expensed the cost of the stapler rather than recognizing it as an
asset to be depreciated over the stapler’s useful life.
11. Full Disclosure/Adequate Disclosure –sufficient information for informed judgment.
Example:
o All material and relevant information should be reported.
12. Consistency - follow the same accounting principle from one accounting period to the next while doing the
financial statements. Reporting must be uniformly employed.
Example:
o Company A – Branch A – FIFO Inventory System/ Straight Line Method (Deprecation)
Branch B – FIFO Inventory System/ Straight Line Method (Deprecation)