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Chapter 2 Accounting Concepts and Principles

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Chapter 2 Accounting Concepts and Principles

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Ryam Enaj Bonito
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© © All Rights Reserved
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ELE02-Special Topics in Accounting

CHAPTER 2 ACCOUNTING CONCEPTS AND PRINCIPLES

Learning Objectives
 Give examples of accounting concepts and principles.
 Apply the concepts in solving accounting problems.
 Illustrate the accounting equation.
 Perform operations involving simple cases with the use of accounting
equation.

 Basic Accounting Concepts


1. Separate entity concept 7. Time Period
2. Historical cost concept 8. Stable monetary unit
3. Going concern assumption 9. Materiality concept
4. Matching 10. Cost-benefit
5. Accrual Basis 11. Full disclosure principle
6. Prudence (or Conservatism) 12. Consistency concept

 Basic Accounting Concepts


1. Separate entity concept – The business is viewed as a separate entity,
distinct from its owner(s). Only the transactions of the business are recorded in
the books of accounts. The personal transactions of the business owner(s) are
not recorded.
2. Historical cost concept (Cost principle) – assets are initially recorded at
their acquisition cost.
3. Going concern assumption – The business is assumed to continue to
exist for an indefinite period of time.
4. Matching – Some costs are initially recognized as assets and charged as
expenses only when the related revenue is recognized.
5. Accrual Basis of accounting – income is recorded in the period when it is
earned rather than when it is collected, while expense is recorded in the period
when it is incurred rather than when it is paid.
ELE02-Special Topics in Accounting

6. Prudence – The observance of some degree of caution when exercising


judgments under conditions of uncertainty. Such that, if there is a choice
between a potentially unfavorable outcome and a potentially favorable
outcome, the unfavorable one is chosen. This is necessary so that assets or
income are not overstated and liabilities or expenses are not understated.
7. Reporting Period – The life of the business is divided into series of
reporting periods.
8. Stable monetary unit – 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.
Therefore, changes in the purchasing power of the peso due to inflation are
ignored.
9. Materiality concept – An item is considered material if its omission or
misstatement could influence economic decisions. Materiality is a matter of
professional judgment and is based on the size and nature of an item being
judged.
10. Cost-benefit – The costs of processing and communicating information
should not exceed the benefits to be derived from the information’s use.
11. Full disclosure principle – Information communicated to users reflect a
balance between detail and conciseness, keeping in mind the cost-benefit
principle.
12. Consistency concept – Like transactions are accounted for in like
manner from period to period.

 Philippine Financial Reporting Standards (PFRSs)


The PFRSs are Standards and Interpretations adopted by the FRSC. They
consist of the following:
1. Philippine Financial Reporting Standards (PFRSs);
2. Philippine Accounting Standards (PASs); and
3. Interpretations

 Qualitative Characteristics
I. Fundamental Qualitative Characteristics
i. Relevance (Predictive Value, Confirmatory Value, Materiality)
ii. Faithful Representation (Completeness, Neutrality, Free from error)

II. Enhancing Qualitative Characteristics


i. Comparability
ii. Verifiability
iii. Timeliness
iv. Understandability

 Fundamental vs. Enhancing


1. The fundamental qualitative characteristics are the characteristics that
make information useful to users.
2. The enhancing qualitative characteristics are the characteristics that
enhance the usefulness of information

 Relevance
ELE02-Special Topics in Accounting

a. Information is relevant if it can affect the decisions of users.


b. Relevant information has the following:
i. Predictive value – the information can be used in making predictions
ii. Confirmatory value – the information can be used in confirming past
predictions

 *Materiality – is an ‘entity-specific’ aspect of relevance.

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

 Enhancing Qualitative Characteristics


1. Comparability – the information helps users in identifying similarities and
differences between different sets of information.
2. Verifiability – different users could reach consensus as to what the
information purports to represent.
3. Timeliness – the information is available to users in time to be able to
influence their decisions.
4. Understandability – users are expected to have:
i. reasonable knowledge of business activities; and
ii. willingness to analyze the information diligently.

 The Accounting Equation

Assets = Liabilities + Equity

 Definitions
a. ASSETS – are the economic resources you control that have resulted from
past events and can provide you with economic benefits.
b. LIABILITIES – are your present obligations that have resulted from past
events and can require you to give up economic resources when settling
them.
c. EQUITY – is assets minus liabilities.

 The Expanded Accounting Equation


Assets = Liabilities + Equity + Income - Expenses

 Definitions
ELE02-Special Topics in Accounting

a. INCOME – is increases in economic benefits during the period in the form


of increases in assets, or decreases in liabilities, that result in increases in
equity, excluding those relating to investments by the business owner.

b. EXPENSES – are decreases in economic benefits during the period in the


form of decreases in assets, or increases in liabilities, that result in
decreases in equity, excluding those relating to distributions to the
business owner.

c. The difference between income and expenses represents profit or loss.

Reference

FINANCIAL ACCOUNTING AND REPORTING (Fundamentals)


Zeus Vernon B. Millan, CPA
Lecture Notes of Compilation of Dean Rene Boy R. Bacay, CPA, CrFA, CMC, MBA, FRIAcc

For further discussion please refer to the link provided:

Chapter 2- Accounting Concepts and Principles- https://youtu.be/fPOcUtfGtxQ

Chapter 2- Accounting Equation-https://youtu.be/OYql7Y9NnBg

Chapter 2- The Expanded Accounting Equation-https://youtu.be/ImMlj6p749o

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