CHAPTER 2 – ACCOUNTING CONCEPTS AND PRINCIPLES

Learning outcomes:
1. Student will be able to basic accounting concepts that underlie the accounting process.
2. Student will be able to give examples of accounting concepts and principles.
3. Student will be able to explain the accounting standards in the Philippines.
4. Student will be able to discuss the role of Conceptual Framework for Financial Reporting in
relation to the development of accounting standards.
5. Student will be able to enumerate the various organizations that are influential to the accounting
profession.
6. Student will be able to apply the concepts in solving accounting problems.

Methodology:
- Courseware/Limited face-to-face

Lecture/Discussion:
Accounting concepts and principles (assumptions or postulates)
▪ Are set of logical ideas and procedures that guide the accountant in recording and
communicating economic information.
▪ They provide a general frame of reference by which accounting practice can be evaluated and
they serve as guide in the development of new practices and procedures.

Basic Accounting Concepts

1. Separate entity concept – Under this concept, the business is viewed as a separate person,
distinct from its owner(s). It follows that only transactions of the business are recorded in the books
of accounts and that personal transactions of the business owner(s) should not be recorded.
2. Historical cost concept (Cost principle) – Under this concept, assets are initially recorded at their
acquisition cost.
3. Going concern assumption – Under this concept, the business is assumed to continue to exist
for an indefinite period of time.
4. Matching principle (Association of cause and effect) – Under this concept, some costs are
initially recognized as assets and charged as expenses only when the related revenue is
recognized.
5. Accrual basis of accounting – Under this concept, economic events are recorded in the period
in which they occur rather than at the point in time when they affect cash. Thus, income is
recognized when it is earned rather than when it is collected, while expenses is recognized when
it is incurred rather than when it is paid.
6. Prudence (or Conservatism) – Under this concept, the accountant observes some degree of
caution when exercising judgments needed in making accounting estimates under conditions of
uncertainty. Such that, if the accountant needs to choose between a potentially unfavorable
outcome versus a potentially favorable outcome, the accountant chooses the unfavorable one.
This is necessary so that assets or income are not overstated and liabilities or expenses are not
understated.
7. Time period (Periodicity, Accounting period, or Reporting Period concept) – Under this
concept, the life of business is divided into series of reporting periods.
8. Stable monetary unit – Under this concept, assets, liabilities, equity, income and expenses are
stated in terms of a common unit of measure, which is the peso in the Philippines. Moreover, the
purchasing power of the peso is regarded as stable. Thus, changes in the purchasing power of
the peso due to inflation are ignored.
9. Materiality concept – This concept guides the accountant when applying accounting principles.
Materiality is a matter of professional judgment and is based on the size and nature of an item
being judged.
10. Cost-benefit (Cost constraint) – Under this concept, the costs of processing and communicating
information should not exceed the benefits to be derived from the information’s use.
11. Full disclosure principle – This concept is related to both the concepts of materiality and cost-
benefit. Under the full disclosure principle, the information communicated to users reflect a series
of judgmental trade-offs that strive for:
a. Sufficient detail to disclose matters that make a difference to users yet,
b. Sufficient condensation to make the information understandable, keeping in mind the cost of
preparing and using it.

12. Consistency concept – This concept requires a business to apply accounting policies
consistently, and present information consistently from one period to another.
Application of the Basic Accounting Concepts:
During the year, you started a business of selling personalized mugs and T-shirts. You opened a
separate bank account for the business and deposited your initial investment of P250,000 to this
account. (Separate entity concept)

The business acquired a printing machine. The regular selling price is P100,000; however, you
were able to acquire it at a discounted price of P90,000. You will record the machine at its acquisition
cost of P90,000 rather than at the regular selling price. (Historical cost concept)

The business acquired initial inventory of mugs and T-shirts for a total cost of P50,000. You will
record the cost as an asset (i.e., inventory) rather than as expense. (Matching concept)

All the inventory was sold on credit for P300,000 (sold on credit means ‘pinautang’ in Filipino).
You will immediately record the credit sales as accounts receivable rather than waiting for them to
be collected (‘accounts receivable’ means ‘listahan ng mga pinautang’ in Filipino). (Accrual basis)

Also, you will now record the P50,000 cost of the inventory as expense. (Matching concept)

You collected P290,000 out of the P300,000 total credit sales. You will deposit the collections to
the bank account of the business rather than to your personal account (Separate entity concept).

The debtor for the remaining P10,000 is in financial difficulty (‘debtor’ means ‘taong umutang’ in
Filipino). This has raised doubt on whether he can pay his account. You will immediately recognize
the doubtful account as expense. (Prudence or Conservatism and Accrual basis)

You withdrew cash of P80,000 from the business for your personal use. You will record this
transaction as a withdrawal of your investment from the business rather than a business expense.
(Separate entity concept)

At the end of the year, you prepared the financial statements of your business to determine,
among others, whether the business has earned profit. (Time period)

When preparing the financial statements, you discovered that the business has $10 dollars. You
will translate this to Philippine peso using the current exchange rate. The amount that you will report
in the financial statements is the translated amount. (Stable monetary unit)

Also, you have found out that the regular selling price of a new printing machine increased from
P100,000 to P120,000. You will ignore this information (Stable monetary unit) and report the printing
machine at its acquisition cost of P90,000 in the financial statements (Historical cost). This is because
you don’t intend or expect to close your business in the foreseeable time (Going concern).

During the year, the business bought a trash bin for P80. You expect to use this over several years.
However, because you deemed the cost as immaterial, you will record this as an expense rather than
as asset. (Materiality)

Moreover, when you prepared the financial statements, you decided to include the cost of the trash
bin in a “Miscellaneous Expenses” account together with other immaterial expenses. You don’t expect
users of the financial statements to benefit from reporting the immaterial cost separately. (Cost-
benefit)

You will make a brief description of the “Miscellaneous Expenses” account in the notes to financial
statements, sufficient for users to understand the nature of this account. (Full disclosure)

You then adopted an accounting policy of expensing outright all acquisitions of equipment
costing P5,000 and below. You will apply this policy consistently in the future periods. (Consistency)
Accounting Standards in the Philippines (Generally Accepted Accounting Principles)
➢ Are laws in accounting (however, principle-based rather than rule based) used as guide in the
preparation of financial statements.
➢ The PFRSs are Standards and Interpretations adopted by the Financial Reporting Standards
Council (FRSC). They consist of the following:
1. Philippine Financial Reporting Standards (PFRSs); (PFRS 1 to 17) (counterpart – IFRS)
2. Philippine Accounting Standards (PASs) (PAS 1 to 41); (counterpart – IAS) and
3. Interpretations
➢ It set out recognition, measurement, presentation and disclosure requirements dealing with
transactions and events that are important in general purpose financial statements.

FRSC has formed the Philippine Interpretations Committee (PIC), which issues implementation
guidance on PFRSs.

Financial Reporting Standard Council (FRSC formerly Accounting Standard Council)

▪ They are the official accounting standard-setting body in the Philippines.
Composition:
▪ A chairman (a Senior Accounting Practitioner)
▪ Fourteen (14) members represented by the ff. sectors:
- (1) for each sector from: BOA, SEC, BSP, BIR, COA, Major organizations (preparers & users of
FS)
- (2) from accredited professional organization – CPA
a. Public Practice c. Education/ Academe
b. Commerce and Industry d. Government

Interpretations are issued to give authoritative guidance on issues that are likely to receive divergent
or unacceptable treatment, in the absence of such guidance.

Who are mandatorily required to follow the accounting standards in the Philippines?
1. Large and/or Publicly Accountable Entities which includes:
a. Shares listed in a public market or are in the process of listing (Initial Public Offering);
b. All financial institutions including banks, insurance companies, security brokers, pension
funds, mutual funds, and investment banking entities;
c. Public Utilities or those supplying goods or services related to electricity, water, gas,
telephone and other communication system
d. Or those entities with total assets of > 350M or total liabilities of > 250M.
2. Small and Medium-sized Entities

Scope:
▪ Applies to all profit-oriented entities preparing general purpose financial statements.

Organizations Influential to the Accounting Profession

Relevant regulatory bodies:
1. Board of Accountancy – is a professional board of CPA in the Philippines who created FRSC under
Professional Regulation Commission (PRC), a government agency administered to register and
regulate professionals in the Philippines.
2. Securities and Exchange Commission (SEC) – is tasked in regulating corporations, including
partnership. The SEC requires the corporations and partnerships to file audited financial
statements.
3. Banko Sentral ng Pilipinas (BSP) – is tasked in regulating banks and other entities performing
banking functions.
4. Bureau of Internal Revenue (BIR) - is tasked in collecting national taxes and administering the
provisions of the Tax Code.
5. Cooperative Development Authority (CDA) – is tasked in regulating cooperatives in the
Philippines.
The Conceptual Framework for Financial Reporting
Conceptual Framework
▪ It is a summary of the terms and concepts that underlie the preparation and presentation of
financial statements.
▪ The underlying concept of the framework is the usefulness of information in making economic
decision.
▪ It is not a Standard and hence does not define standard for any particular measurement or
disclosure issue.

Scope:
▪ Concerned only with the general-purpose financial statements, including consolidated financial
statements.

Purpose:
Basic:
▪ It serves as a guide or reference in developing future PFRS and in resolving accounting issues not
directly addressed by existing PFRS.

Specific:
▪ To assist International Accounting Standards Board (IASB) in developing Standards that are based
on consistent concepts;
▪ To assist preparers in developing consistent accounting policies when no Standard applies to a
particular transaction or when a standard allows a choice of accounting policy; and
▪ To assist all parties in understanding and interpreting the Standards.

Scope of the Conceptual Framework

➢ The Conceptual Framework is concerned with general purpose financial reporting. General
purpose financial reporting involves the preparation of general-purpose financial statements. The
Conceptual Framework provides the concepts regarding the following:
1. The objective of financial reporting
2. Qualitative characteristics of useful financial information
3. Financial statements and the reporting entity
4. The elements of financial statements
5. Recognition and derecognition
6. Measurement

Qualitative Characteristics of useful financial information

➢ Qualitative characteristics are the traits that determine whether an item of information is useful to
users. Without these characteristics, the information may be deemed useless.
➢ The qualitative characteristics are broadly classified into two, namely:
I. Fundamental Qualitative Characteristics – these are the characteristics that make the
information useful to users. They consist of the following:
a. Relevance (Predictive Value, Confirmatory Value, Materiality)
b. Faithful Representation (Completeness, Neutrality, Free from error)

II. Enhancing Qualitative Characteristics – these characteristics support the fundamental

characteristics. They enhance the usefulness of information. They consist of the following:
a. Comparability
b. Verifiability
c. Timeliness
d. Understandability

Relevance
▪ Information is relevant if it can affect the decisions of users.
▪ Relevant information has the following:
a. Predictive value – the information can be used in making predictions
b. Confirmatory value – the information can be used in confirming past predictions
Materiality – is an ‘entity-specific’ aspect of relevance.

Faithful Representation
▪ Faithful representation means the information provides a true, correct and complete depiction of
what it purports to represent.
▪ Faithfully represented information has the following:
a. Completeness – all information necessary for users to understand the phenomenon being
depicted is provided.
b. Neutrality – information is selected or presented without bias.
c. Free from error – there are no errors in the description and in the process by which the
information is selected and applied.

Comparability – information is comparable if it can help users identify similarities and differences
between different sets of information.

Verifiability – information is verifiable if different users could reach a general agreement as to what
the information intends to represent.

Timeliness – information is timely if it is available to users in time to be able to influence their

decisions.

Understandability – information is understandable if it presented in a clear and concise manner. On

the other hand, users are expected to have:
a. reasonable knowledge of business activities; and
b. willingness to analyze the information diligently.

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ACTIVITIES/ASSESSMENT TASK:
Instructions:
1. Ask kindly and politely a classmate (preferably someone who is not lazy) to be your study
partner.
2. Imagine you and your classmate are business partners.
3. Discuss among yourselves how you can apply the basic accounting concepts listed below to
grow your business.
a. Separate entity concept
b. Time period
c. Historical cost concept
d. Materiality concept
e. Matching
f. Accrual basis of accounting
g. Going concern

Note: Your answers must be practical, meaning they are applicable in real-life settings. Don’t just
copy the provided definitions. YOU WILL BE GRADED NOT ON ACCURACY BUT ON HOW
CLOSELY YOUR ANSWERS SIMULATE REAL-LIFE SETTING! Use your imagination, be creative, but
most of all……. enjoy! Good luck

Final note: The list above is just a list of the concepts you need to consider. You don’t need to follow
exactly the sequence in the list.

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