ACCOUNTING CONCEPTS AND

PRINCIPLES

CHAPTER 6
 MEANING OF ACCCOUNTING
CONCEPTS AND PRINCIPLES
determine income, expenses, assets and liabilities for financial
reporting. Companies implement these principles while
preparing financial statements to make them consistent and
complete. These properly formulated financial statements help
investors in analyzing useful information.

 Accounting assumptions are the basic notions or fundamental premises on which the accounting
process is based. Accounting assumptions are also known as postulates.

Accounting assumptions serve as the foundation or bedrock of accounting in order to avoid

misunderstanding but rather enhance the understanding and usefulness of the financial statements.

a. MONEY UNIT or the monetary unit assumption has two aspects, namely quantifiability and stability of the
peso.

The quantifiability aspects - 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 constant and that its
stability is insignificant and therefore may be ignored.
The stable peso postulate is actually an amplification of the going concern assumption so much so that
adjustments are unnecessary to reflect any changes in purchasing power.
 Basic assumption

b. Economic Entity -
is an accounting principle that
separates the transactions carried
out by the business from its owner.
It can also refer to the separation
between various divisions in a
company. Each unit maintains its
own accounting records specific to
the business operations.
- the financial records of each of the
divisions should be kept separately
 Underlying assumption

c. Going concern or Continuity Assumption

– the financial statements are normally
prepared on the assumption that an entity is
a going concern and will continue in
operation for the foreseeable future. Hence,
it is assumed that the entity has neither the
intention nor the need liquidate or curtail
materially the scale of its operations; if such
an intention or need exists, the financial
statements may have to be prepared on a
different basis and if so, the basis used is
disclosed.
• d. Time period – 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, performance and cash flows
• By convention, the accounting period or fiscal period
is one year or a period of twelve months. The one
year period is traditionally the accounting period
because usually it is after one year that government
reports are required.
• The accounting period may be a calendar year or a
natural business year.
• A calendar year is a twelve month period that ends
on December 31. A natural business year is a twelve
month period that ends on any month when the
business is at the lowest or experiencing slack season.
ACCOUNTING CONCEPTS

the basic assumptions and rules and principles which work as the basis
of recording of business transactions and preparing accounts.
Revenue Recognition Principle.
Revenues are recognized as soon as
goods have been sold or services
has been rendered, regardless of
when the money is actually
received. Revenue is recognized
when the earning process is
virtually complete and an exchange
transaction has occurred.
 Matching Principle. Expenses are recognized in the same period as the
related revenue. Revenues of a business always come with expenses. No
business can generate revenues without incurring expenses. The matching
principle states that related revenues and expenses should always go
together. In other words, if the revenues are recorded in period 1, the
related expenses should also be recorded in period 1.

Moreover, under the matching principle, there is a cause-and-effect

relationship between revenues and expenses. If this relationship does not
exist between revenues and expenses, the expenses should be recognized
immediately n the accounting records of the company. Advertising and
marketing expenses are the most common examples of this kind of expense.
Since the related benefit that is expected to be derived from advertising and
marketing cannot be measured reliably, these expenses are recognized
immediately.
FULL DISCLOSURE PRINCIPLE. In the preparation of financial
statements, the accountant should include sufficient information to
permit the stakeholders to make an informed judgement about the
financial condition of the enterprise. The information should be
disclosed within the statement or in the notes to the statement.
The full disclosure principle requires a company to provide the necessary
information so that people who are accustomed to reading financial
information are able to make informed decisions regarding the company.
Historical Cost - a company or
business must account for and
record all assets at the original cost
or purchase price on their balance
sheet. No adjustments are made to
reflect fluctuations in the market or
changes resulting from inflationary
fluctuations

For example, the historical cost of an office

building was $10 million when it was
purchased 20 years ago, but its current
market value is three times that figure
Accounting constraints
Materiality Principle
Business transaction that may affect the decision of a
user of financial information are considered important
or material, and must be reported properly.
This principle allows an accountant to violate
another accounting principle if an amount is
insignificant. Professional judgment is needed to decide
whether an amount is insignificant or immaterial.
  Conservatism or Prudence Principle
This principle states that given two option in the valuation of business
transactions, the amount recorded should be lower rather than higher
value. If situation arises where there are two acceptable alternatives for
reporting an item, conservatism directs the accountants to choose the
alternative that will result in less effect on net income or less asset
amount.
Conservatism help the accountant break a tie while remaining
unbiased or objective. It leads the accountant to anticipate or disclose
losses
 CONSERVATISM - is a principle that
requires company accounts to be prepared
with caution and high degrees of
verification. All probable losses are recorded
when they are discovered, while gains can
only be registered when they are fully
realized.
 For example, a company that expects to win
litigation is obliged to meet all the
requirements of revenue recognition before
it reports the gains. However, the company
must record the economic loss if it expects
to lose a lawsuit.
COST PRINCIPLE - Cost refers to the amount of spent when an item was
originally obtained, whether that purchase happened before; amounts
are not adjusted upward for inflation. The amount shown in the
financial statement are referred to as historical cost amounts.
The accounting guideline requiring amounts in the accounts and on the
financial statements to be the actual cost rather than the current value.
Accountants can show an amount less than cost due to conservatism, but
accountants are generally prohibited from showing amounts greater than
cost. (Certain investments will be shown at fair value instead of cost.)
 Objectivity Principle
This principle require business transactions to have some form of
impartial supporting evidence or documentation. Also, it entails that
bookkeeping and financial recording be performed with independence,
that is free of bias and prejudice.
The objectivity principle states that financial and accounting
information needs to be independent and free from bias. This means
that financial reporting like a company’s financial statements need to
be based on evidence and not opinions.
 Generally Accepted
Accounting
Principles (GAAP)
•
Consist of accounting principles, standards, rules, and
guidelines that companies follow to achieve
consistency and comparability in their financial
statements. The principles have developed on the
basis of experience, reason, custom, usage and
practical necessity.
The process of establishing GAAP is social processes
which incorporate political actions of various
interested user groups as well as professional
judgment, logic and research.
Purpose of Accounting Standards

• The overall purpose of accounting standards is to identify proper

accounting practices for the preparation and presentation of financial
statements.
• Accounting standards create a common understanding between
prepares and users of financial statements particularly the
measurement of assets and liabilities. A set of high-quality accounting
standards is a necessity to ensure comparability and uniformity in
financial statements based on the same financial information.
•