Accounting Concepts and

Principles
FABM1
Objectives

1. Explain the varied

accounting concepts and
principles; and
2. Solve exercises on
accounting principles as
applied in various cases.

2
 Underlying
Accounting Assumptions

3
Economic Entity Assumption

According to accounting entity assumption, the

business is separate from the owners, managers, and
the employees operating the business. Likewise, if the
person owns multiple businesses, each business is
different from all the others. This means that if a person
has three businesses, then each business should keep
its own accounting records. The assets and liabilities of
each business should not be mixed up.
4
Illustration
Jim, an owner of a pizza shop, decides to buy a new
delivery car. Since the company was low on cash, Jim
decided to pay for the car himself out of his personal
bank account. Jim intends to add the car to
the balance sheet of the pizza shop. The economic
entity principle requires Jim and his company to keep
activities separated, so the car must remain a
personal vehicle unless Jim contributes it to the
company or the company buys it from Jim personally.

5
Accrual Basis Assumption

The effects of business transactions should be

recognized in the period in which they occurred. Income
should be recognize in the period when it is earned
regardless of when the payment is received. Expenses
should be recognized in the period when it is incurred
regardless of when the expenses are paid.
6
Illustration

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.

7
Going Concern Assumption

The going concern assumption states that the

operations of a business will not stop in the near future
and it will not be forced to liquidate its assets to pay off
its liabilities. The going concern assumption allows
accountants to defer recognition of expenses in the
future.

8
Illustration
Company A rents a building for P100,000 per month. On
January 01, 2024, the company pay the rent for 2 years in the
amount of P2,400,000. Under the going concern assumption,
the company can recognize the part of the P2,400,000 that is
not yet incurred. On January 01, 2024, the company has yet
to used the building but already paid the rent. In this case, the
accountant can record an asset (prepaid expense) instead of
recognizing an expense immediately. If the entity is not a
going concern, there is no point recognizing the payment as
an asset since the company will not derived all benefits from
it.

9
Monetary Unit Assumption

According to this principle, all business transactions

should be recorded in one single monetary unit. Thus,
economic activities of a Philippine entity are measured
and reported in Philippine Peso (Php). The peso is
assumed to remain relatively stable over the years in
terms of purchasing power. It disregards any inflation in
economy in which the entity operates.
10
Illustration
❖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.

11
Time Period Assumption

This assumption states that the indefinite life of a company can

be divided into periods of equal length for the preparation of
financial reports like monthly, quarterly or annually. Normally,
the period span for one year. Every year, most businesses
produce financial reports for the benefit of the users of
accounting information.
The accounting period may be a calendar year or a fiscal year. A
calendar year is a 12-month period that ends on December 31st.
A fiscal year is a 12-month period that ends on any month of
the year. 12
Illustration
The Meta company provides services valuing Php
2,500 to Beta company during the first quarter of the
year. The Beta company will pay the cash for these
services next quarter. According to time period
assumption, if Meta company prepares its financial
statements at the end of the first quarter of the year,
it must include this service revenue of Php 2,500 in
its income statement for the first quarter.

13
Basic Accounting Principles

14
Cost Principle

Under this principle, all accounts should be recorded

initially at cost. Cost refers to the amount spent (cash or
cash equivalent) when an item is originally obtained,
whether that purchased happened last year or ten years
ago; amounts are just adjusted upward for inflation.

15
Illustration

❑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.
16
Full Disclosure Principle

In the preparation of the financial statements, the

accountant should include sufficient information to
permit the stakeholders to make and informed
judgment about the financial condition of the
enterprise.

17
Illustration

If certain information is important to an

investor or lender using the financial
statements, that information should be
disclosed within the statement or in the
notes of the statement. A company
usually list its significant accounting
policies as the first notes to its financial
statements.
18
Matching Principle

Under this principle, expenses are recognized in the

same period as the related revenue. It means that in a
given accounting period, the revenue recorded should
have its corresponding expense recorded, in order to
show the true profit of the business.

19
Illustration

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.

20
Revenue Recognition Principle

Revenues are recognized as soon as goods have been

sold (delivered to the customers) or a service has been
rendered, regardless of when the money is actually
received.

21
Illustration

On June 25, Cho Chang Repair shop rendered

service to a client for P25,000. The service fee
was collected a month after. With revenue
recognition principle, the entity should record
the revenue on June 25, the time the service
was rendered to the customer and not during
the time the payment was received.

22
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.

This principle allows an accountant to violate another

accounting principle (matching principle) if an amount is
insignificant or immaterial. Professional judgment is needed to
decide whether an amount is insignificant or immaterial.
23
Illustration

A school purchased an eraser with an

estimated useful life of three years for P50.00.
Since an eraser is immaterial relative to
assets, it should be recorded as an expense.

24
Prudence Principle

Prudence in accounting is also called conservatism.

Prudence means exercising care in decisions regarding
recognition of items in the accounting records. In case
of doubt, expenses should be recorded at a higher
amount. Revenue should be recorded at a lower
amount.

25
Illustration
Some of the financial transactions are sometimes uncertain
when they occur (like the warranty expense in the previous
illustration). Nevertheless, we still have to report these
transactions if they pertain to a specific period. In reporting
these transactions, an accountant needs to apply the concept
of prudence.

Prudence would also be exercised in setting up, an allowance

for doubtful accounts or a reserve for obsolete inventory. In
both cases, a specific item that will cause an expense has not
yet been identified, but a prudent person would record a
reserve in anticipation of a reasonable amount of these
expenses arising at some point in the future.
26
Use of Judgment and Estimates

Accounting estimates are approximations made by

accountants or the management in the preparation of
financial statements. The use of reasonable estimates is
an essential part of the preparation of financial
statements and does not undermine their reliability.

27
Illustration
Some of the items in the company’s accounting records such as cash,
property, plant and equipment, accounts payable, etc. can be measured
precisely. But there are items in the accounting records that cannot be
exactly measured. Thus, these items require the use of accounting
estimates. For instance, warranty expense. A warranty is a guarantee made
by the seller to the buyer promising to repair or replace the thing sold if
necessary within a specified period of time. When a sellers sells goods,
there are revenues generated that are recorded in the company’s
accounting record. According to the matching principle, all related expenses
should be recorded in the same period the revenues are recognized. The
problem is, what amount of warranty the company should recognize in the
accounting records. Thus, the warranty expense in the company’s
accounting records is usually estimated based on historical data.

28
Objectivity Principle

This principle requires business transactions to have

some form of impartial supporting evidence or
documentation. Also, it entails the bookkeeping and
financial recording be performed with independence,
that is free of bias and prejudice.

29
Illustration
The purchase of merchandise from a vendor requires
an invoice to support the transaction. This invoice
should be approved by the Bureau of Internal
Revenue and should state the name of the supplier,
the description, quantity, and the value of the goods
purchased. Utility expense must be supported by
statement of account from utility companies like
SOCOTECO and MarbelTel.

30
Substance Over Form

Information presented in the financial statements of a

company should truthfully and faithfully represent the
financial condition and financial performance of the
company. For this to be possible, an accountant should
look at the substance of every financial transaction
rather than its form.

31
Illustration
A transaction where the substance differs from the legal form
is a lease. In a lease, the lessor allows the lessee to use the
former’s property in exchange of a periodic fee. However,
when the ownership of the property transfers to the lessee at
the end of the lease, the substance differ from the legal form.
In this case, the transaction is really a sale of property with
installment payment instead of a lease. The lessee will record
an asset and a liability in his/her accounting records instead of
recognizing an expense.

When the substance differ from the legal form, follow the
substance of the transaction. In the illustration given, the
substance is a sale of property in installment payments while
the legal form is a lease. 32
Set of
Accounting
Standards

33
GAAP
Generally Accepted Accounting
Principle

This consists of accounting

principles, standards, rules,
and guidelines that companies
follow to achieve consistency
and comparability in their
financial statements.

34
IFRS
International Financial Reporting
Standards
these are pronouncements issued by the
International Accounting Standards
Board (IASB) that intend to enhance the
comparability of financial statements all
over the world. In light of globalization,
the IFRS will provide a way for users of
accounting information to easy
understand the results of operation of
companies all around the globe.
*Philippines is fully compliant with the
IFRS effective January 2005. 35
 PFRS
Philippine Financial Reporting
Standards
The Philippine Financial Reporting Standards
Council (PFRSC) issues standards to be used
in the Philippines in the form of Philippine
Financial Reporting Standards (PFRS). The
PFRS includes the ff:
a. PFRS which corresponds to IFRS
b. PAS which corresponds to IAS
c. Interpretation of accounting standards
issued by the Philippine Interpretations
Committee in accordance with the
interpretations of the International Financial
Interpretations Committee (IFRIC) and the
Standing Interpretations Committee 36
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YOU!
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