FUNDAMENTALS OF ACCOUNTANCY, BUSINESS

AND MANAGEMENT 1
TOPIC 6:
ACCOUNTING CONCEPTS AND PRINCIPLES

Objectives:
 Enumerate the principles of Accounting
 Differentiate each principle
 Apply each principle in the business setting
REVIEW OF THE ACCOUNTING LESSONS.
ACCOUNTING CONCEPTS AND PRINCIPLES

Accounting concepts, principles and assumptions are essential in the practice of accountancy.
Financial Statements become more comparable and more useful to users if these concepts,
principles, and assumptions are followed by businesses.

Accounting concepts, principles and assumptions serve as the foundation of accounting in order to
avoid misunderstanding and enhance the understanding and usefulness of the financial statements.
ACCOUNTING CONCEPTS AND PRINCIPLES

1. Accrual Accounting
2. Matching Principle
3. Use of judgment and estimates
4. Prudence
5. Substance over form
6. Going Concern assumption
7. Accounting entity assumption
8. Time period assumption
9. Generally Accepted Accounting Principles (GAAP)
10.International Financial Reporting Standards (IFRS) and Philippine
Financial Reporting Standards (PFRS)
1. ACCRUAL ACCOUNTING

“The effects of business transactions should be recognized in the period in

which they occurred. Income should be recognized 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.”
1. ACCRUAL ACCOUNTING

The Accountant does not have to wait for the cash to be received or for cash
to be paid before he or she records a business transactions. Because of
Accrual Accounting, the Accountant can use
• Accounts Receivable, Accounts Payable, Pre-paid expenses, Accrued
Expenses, Deferred income and Accrued Income to record the business transactions.

Accrual Accounting also results in FS that are more accurate and more reliable in terms of
assessing the past performance of the company.
1. ACCRUAL ACCOUNTING

The opposite of Accrual Accounting is

the Cash basis of Accounting.
Cash basis of Accounting- income is
recognized when cash is received and
expenses are recognized when cash is
paid.
The receipt and/ or payment of cash is
a requisite before transactions are
recorded in the accounting records of
the company.
2. MATCHING PRINCIPLE
Under 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.
If the revenues are recorded in period 1, the related expenses
should also be recorded in period 1.

-Matching principle provides more accurate and more reliable

information in the FS. It prevents understatement of expenses
in one period while overstating in the next period.

-Matching principle has a cause-and-effect relationship

between revenues and expenses. If does not exist, recognized
immediately the expense.
3. 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 FS and does not undermine their reliability.

Ex. Warranty expense

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. But the company is not sure when the warranties will
be performed by the company to the client. Thus, the company will use estimated cost based on
historical data.

However, the use of accounting estimates should not be abused by the company. Judgment used in
making estimates should be backed by a reasonable basis and should be part of the disclosures in the
FS.
4. PRUDENCE

Prudence in Accounting is also called CONSERVATISM. According to Valix et al.(2013),

In the simplest words, CONSERVATISM means in case of doubt, record any loss and do
not record any gain.
For example, when an Accountant is unsure whether or not to recognize an expense, the
concept of prudence states that he or she should recognize in the accounting records. On
the other hand, if an Accountant is unsure whether or not to recognize income, prudence
states that he or she should bot recognize it.
When applying the concept of prudence, an Accountant makes sure that income and assets
are not overstated and liabilities and expenses are not overstated.

• 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: In case of doubt, expenses should be recorded at a higher amount. Revenue should be recorded at a lower
amount.
5. SUBSTANCE OVER FORM

Information presented in the FS 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 transactions rather than its legal form.

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

When the substance differs from the legal form, follow the substance of the transaction.
5. SUBSTANCE OVER FORM
6. GOING CONCERN ASSUMPTION

The Going Concern Assumption states that the operations of a business will continue indefinitely into the future.
This means 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.

Going concern principle – business is expected to continue indefinitely.

Example: When preparing financial statements, you should assume that the entity will continue indefinitely.

However, if there is substantial doubt about the ability of a company to continue, the company can abandon the
assumption. The following items are evidences that company is not going concern:
• The results of operations consistently show losses.
• Inability to pay the obligations of the company in time
• Loan defaults
• Suppliers do not sell on credit to the company
• Legal proceedings against the company
7. ACCOUNTING ENTITY ASSUMPTION

Accounting Entity Assumptions, the business is separate from the owners, managers and employees operating the
business. Likewise, if a person owns multiple businesses, each business is distinct from all others. And if the
person has three businesses, then each business will keep its own accounting records. The assets and liabilities of
the three businesses should not be mixed with one another.
The same with :
• Business entity principle – a business enterprise is separate and distinct from its owner or investor.
Examples :
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.

The main purpose of the accounting entity assumption is for the fair presentation of the FS of the company.
8. TIME PERIOD ASSUMPTION

Users of the accounting information need periodic reports to enable them to make economic decisions.

The Time Period assumption states that the indefinite life of a company can be divided into periods of equal
length for the preparation of the Financial reports. Normally, the period span for one year. Every year, most
businesses produce FS for the benefit of the users of Accounting information.

Time period principle – financial statements are to be divided into specific time intervals.
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.

Accounting Period may be CALENDAR YEAR OR FISCAL YEAR.

Calendar year is a 12-month period that ends on December 31.
Fiscal year is a 12-month period that ends on any month of the year.
9. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

The Generally Accepted Accounting Principles (GAAP) consists of accounting principles,

standards, rules and guidelines that companies follow to achieve consistency and comparability in
their FS. Companies that apply GAAP help not only external users of accounting information, but
also the management as well. GAAP also helps the management in understanding trends persistent
in the company. Management can also compare past and current performance to check the strong
and weak points of company operations.

Another feature of GAAP is that it is agreed upon by practitioners. Individuals in the accountancy
profession are the one who create accounting standards such as the GAAP. The formulation,
development, and modifications of the GAAP go through a rigorous process involving professional
judgement and research.
10. IFRS AND PFRS

The International Financial Reporting Standards (IFRS) are pronouncements issued by the International
Accounting Standards Board (IASB) that intend to enhance the comparability of the financial statements of all
companies, around the world. In light of globalization, the IFRS will provide a way for users of accounting
information to easily understand the results of operations of companies all around the globe.

The Philippine Financial Reporting Standards Council (IFRSC) issues standards to be used in the Philippines in
the form of Philippines Financial Reporting Standards (PFRS). These includes the following:
• Philippine Financial Reporting Standard (PFRS) which corresponds to International Financial Reporting
Standards (IFRS)
• Philippines Accounting Standards (PAS) which corresponds to the International Accounting Standards (IAS)
• Interpretations of Accounting Standards issued by the Philippine Interpretations Committee in accordance
with interpretations of the International Financial Reporting Interpretations Committee (IFRIC) and the
Standing Interpretations Committee
 OTHER PRINCIPLES

Monetary unit principle – amounts are stated into a single monetary unit (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

Objectivity principle – financial statements must be presented with supporting evidence.

Example :
o When the customer paid Jollibee for their order, Jollibee should have a copy of the receipt to represent as evidence.
35
o When a company incurred a transportation expense, a voucher should be prepared as evidence.
 OTHER PRINCIPLES

Cost principle – accounts should be recorded initially at cost.

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.

• Disclosure principle – all relevant and material information should be reported.

Example:
The company should report all relevant information.

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.
ACTIVITY 6