FUNDAMENTALS OF

ACCOUNTANCY, BUSINESS AND

MANAGEMENT 1
VI. Accounting Concepts and Principles
Accounting Concepts and Principles
Petness First Petshop
 Juan dela Cruz opened his pet shop business called Petness
First Petshop. He opened a bank account for his business
and deposited PHP500,000. The business earned PHP50,000
but he had doubts with the recorded expense of PHP60,000.
Which item/s should be included as expenses? Excluded as
expenses?

Salary expense 20,000

Rent expense 10,000
Utilities expense (Owner) 15,000
Utilities expense (store) 10,000
Insurance expense 5,000
Withdrawals 10,000
TOTAL 70,000
Accounting Concepts and Principles
 Salary expense
◦ it should be included since it is related to
the operations of the business
 Rent expense

◦ it should be included since the rent is for

the business
 Utilities expense (owner/home)

◦ it should not be included; it is a personal

expense
Accounting Concepts and Principles
 Utilitiesexpense (store)
◦ should be included; it is an expense
of the business
 Insurance expense

◦ – should be included since the

insurance is for the business
 Withdrawals – should not be included

since the withdrawal is for personal

use.
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.
Accounting Concepts and Principles
 Basic accounting principles and concepts:
 Business entity principle
◦ a business enterprise is separate and distinct from
its owner or investor.
 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.
Accounting Concepts and Principles
 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
◦ business is expected to continue indefinitely.
 Example:
◦ When preparing financial statements, you should
assume that the entity will continue indefinitely.
◦ Possible losses from the closure of business cannot
be anticipated in the accounts.
Accounting Concepts and Principles
Time period principle
◦ financial statements are to be divided into specific
time intervals.

 Example
◦ Philippine companies are required to report
financial statements annually.
◦ The salary expenses from January to December
2015 should only be reported in 2015.
Accounting Concepts and Principles
 Monetary unit principle
◦ amounts are stated into a single monetary unit.

 Example :
◦ Jollibee should report financial statements in pesos
even if they have a store in the United States.
◦ McDonalds should report financial statements in
dollars even if they have a branch here in the
Philippines.
Accounting Concepts and Principles
 Objectivity principle
◦ financial statements must be presented with
supporting evidence and free from bias.
◦ Is aimed at making financial statements more
relevant and reliable.
 Example :
◦ When the customer paid Jollibee for their order,
Jollibee should have a copy of the receipt to
represent as evidence.
◦ When a company incurred a transportation expense,
a voucher should be prepared as evidence.
Accounting Concepts and Principles

 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.
Accounting Concepts and Principles
 Cost principle
◦ accounts should be recorded initially at cost.

 Example :
◦ 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.
Accounting Concepts and Principles
 Accrual Accounting Principle
◦ revenue should be recognized when earned
regardless of collection and expenses should be
recognized when incurred regardless of payment.

 Example:
◦ When a barber finishes performing his services he
should record it as revenue even if he is yet to
receive the payment.
◦ When the barber shop receives an electricity bill, it
should record it as an expense even if it is unpaid.
Accounting Concepts and Principles
 Matching principle
◦ cost should be matched with the revenue generated
simultaneously.

 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.
Accounting Concepts and Principles
Matching principle
  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.
Accounting Concepts and Principles
 Disclosure principle
◦ all relevant and material information should be
reported. Financial statements should be prepared
to reflect a true and fair view of the financial
position and performance of the enterprise.
 Example:
 The company should report all relevant

information.
Accounting Concepts and Principles
 Conservatism principle
◦ also known as prudence. In case of doubt, assets
and income should not be overstated while
liabilities and expenses should not be understated.

 Example:
◦ Expenses should be recorded at a higher amount.
◦ Revenue should be recorded at a lower amount.
Conservatism principle

 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.
Accounting Concepts and Principles
 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.

 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.
Materiality principle

 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.
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.
 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.
 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.
Accounting Concepts and Principles

Consistency Principle
 The consistency principle states that
companies should use the same accounting
treatment for similar events and transactions
over time.
Consistency Principle
 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.
Accounting Concepts and Principles

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.
Revenue Recognition Principle
 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.
Qualitative Characteristics of
Financial Information
 RELEVANCE
 The concept of relevance implies that
financial statements can have
predictive value and feedback value.
 Three main characteristics of relevant

accounting information:
 predictive value
 feedback value
 timeless.
Three main characteristics of relevant
accounting information:
 PREDICTIVE VALUE
 Predictivevalue 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.
 Three main characteristics of
relevant accounting information:
 FEEDBACK VALUE
 Quality information has a feedback value when

it can confirm or correct previous expectations.

 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.
 Qualitative Characteristics of
Financial Information
 RELIABILITY
 The concept of reliability implies that financial

information can be verified by many source with

evidence and that all financial information is
presented.
 Three main attributes that all reliable financial

information has:
 verifiability
 representational faithfulness
 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.
 NEUTRALITY
 Finally, 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.
Qualitative Characteristics of
Financial Information
 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.
 Accounting Concepts and Principles
 RECAP:
◦ Business Entity
◦ Going Concern
◦ Time Period
◦ Monetary Unit
◦ Objectivity
◦ Cost
◦ Accrual Accounting
◦ Matching
◦ Disclosure
◦ Conservatism
◦ Materiality
◦ Historical Cost
◦ Accounting Period
◦ Consistency Principle
◦ Revenue Recognition Principle
QUIZ