Unit 3: Accounting Concepts and Principles

3.1 Conceptual Framework of Accounting

Conceptual Framework of Accounting sets out the agreed concepts that underlying the
preparation and presentation of financial statements for external users. Emphasizing the word
“framework”, the conceptual framework of accounting serves as a “theoretical foundation” that
assists the standard-setting body in developing new and reviewing existing reporting standards.
The framework aims to harmonize the regulations, accounting standards, and procedures about
the preparation of financial statements. In addendum, the framework also helps users of financial
information to interpret financial statements.

3.1.1 Scope of Conceptual Framework

* Objective of financial reporting

* Qualitative characteristics of useful financial information
* Definition, recognition and measurement of the elements from which financial
statements are constructed
* Concept of capital and capital maintenance

3.1.2 Qualitative Characteristics of Useful Financial Information

a. Fundamental Qualitative Characteristics

➢ Relevance. Financial information is relevant if it is capable of making a
difference to the decisions made by users. This means that information
becomes relevant when it can affect the decisions of the users. Relevant
information can facilitate in predicting future trends and confirming past
predictions.
➢ Faithful Representation. Financial information is said to be faithfully
represented when it presents what really existed or happened. Accounting
information must be complete, neutral, and free from material error.
b. Enhancing Qualitative Characteristics
➢ Verifiability. Accounting information must be supported by evidence and
that independent individuals can obtain similar results when same
measurement methods are used.

➢ Comparability. Users of information are able to identify similarities and

differences between economic events.

Comparison of financial reporting from different entities but engaged in

the same industry is called “inter-comparability” while comparison of
 financial information within one (1) company but through different periods
is called “intra-comparability”

➢ Understandability. Users must be able to perceive the significance of the

information presented. Reasonable knowledge in accounting is required in
the spirit of understandability because a person having no background will
definitely not understand the financial information no matter how well it is
presented.

➢ Timeliness. Information must be available to decision-makers at the time

it is needed.

3.2 Accounting Principles

The Generally Accepted Accounting Principles (GAAP) governs and guides the preparation of
financial statements. These are uniform set of accounting rules, procedures, practices and
standards for the preparation of financial statements. Among the principles are:

➢ Cost Principle

This principle defines “cost” as the amount spent when an item is originally
acquired notwithstanding the timing of purchase. Items bought are recorded
based on the actual cash or original cost of acquisition and not based on the
prevailing market price or future value.

So, if you buy an office equipment for ₱35,000, the transaction shall be recorded
at ₱35,000.

➢ Full Disclosure Principle

In relation to accounting, full disclosure means that an accountant should make

sufficient information known to the users to make way for a sound judgment
about financial conditions and performance of the business. Take note that it’s
not just disclosure but FULL DISCLOSURE, hence we emphasize “SUFFICIENT
information” that are significant based on the needs of the users of information.

➢ Revenue Recognition Principle

The word REVENUE refers to an income item generated from “normal business
operations”. Normal operations, are the “usual activities” or the things that are
done by the business on a regular basis.
 A good example would be the income of a tailor from making clothes. The usual
activity of a tailor is to make dresses, shirts, and the like. So, the income that the
tailor earns from such an activity is labelled as revenue because it is derived from
his usual activity which is tailoring. If he earns an income outside of that (not his
usual activity), then it is NOT a revenue.

The Revenue Recognition Principle states that revenues are recognized as soon
as the goods have been sold (delivered to the customers) or a service has been
rendered, REGARDLESS of when the money is actually received.

Applying the principle to the tailoring business mentioned above, the tailor can
already claim that he has earned an income if he has already rendered his service
to his clients even if the clients DID NOT pay him YET. If the clients pay him in
advance without fulfilling his part, there is NO REVENUE YET.

This means that the basis for recognizing revenue is NOT the time on which the
business receives the payment from customers but it is on the POINT OF
RENDERING THE SERVICE or DELIVERY OF GOODS.

➢ Matching Principle

The things being MATCHED here are the revenues (income) and expenses. This
principle plays around the idea that for revenue recorded, there is a related
expense that also needs to be recorded.

Examples:

a. The money received by a carpenter from his customers would be his revenue
(income) while the amount he spends for the electricity in his shop will be his
expense.

b. A fashion designer for haute couture earns revenues from selling his
collections (clothes) to his clients. His expenses would come from the salaries
of his artisans, etc.

c. The owner of commercial building can have his revenues from the rental of
the tenants and his expenses would be in the form of maintenance cost of his
property.

➢ Objectivity Principle

Being objective means being able to consider and represent facts without the
influence of biases and prejudices. In relation to accounting, this principle requires
 business transactions to have some form of impartial supporting evidence or
documentation.

➢ Cost-Benefit Principle

The benefits that can be derived from providing accounting information should
EXCEED the cost of releasing the same information.

➢ Conservatism or Prudence

The application of this principle leads accountants to anticipate losses rather than
profits. When talking about income and/or assets, lower amounts are chosen. This
doesn’t mean though that accountants will deliberately reduce the amount of
income and/or assets.

3.3 Accounting Assumptions

➢ Going Concern Assumption. Under this assumption, the business is assumed to

remain in existence for an indeterminate period of time in the absence of any
information to the contrary.

In other words, the business is assumed to continue to exist if there is no clear

evidence that it will end.

➢ Economic Entity Assumption. This assumption suggests the separation of the

business transactions from the personal affairs of the owner. Any event not
related to the business must not be mixed with the records of the company.

➢ Accrual Basis Assumption. This requires that business transactions enter the
accounting records as they occur instead of when the cash or cash equivalent is
received or paid.

Revenues are recorded when they are earned, regardless of the timing when
payments are received (recall the Revenue Recognition Principle).

Expenses are recorded when they are incurred, regardless of the time that cash is
given as payment. This simply means that expenses can already exist even before
you pay for them. An example would be your building rental. As long as you are
already occupying the space for your shop, you are already incurring an expense
even if payment is due at the end of the month.

➢ Monetary Unit Assumption. The Philippine peso, being the official currency of the
country, is used in measuring and reporting economic activities of a Philippine
 entity. Accordingly, when payments are received in foreign currency
denomination, the same shall be converted into Philippine peso.

➢ Time-Period Assumption. This requires a business entity to complete the whole

accounting process over a specific operating time period. With this, the company’s
financial statements are prepared at equal time intervals.