ACCOUNTING CONCEPTS

AND PRINCIPLES
BASIC ACCOUNTING ASSUMPTIONS

1. Going Concern Assumption

 The underlying assumption in the preparation of financial statements is
the going concern assumption.

 Financial statements are prepared on the assumption that the entity will
continue in operation into the foreseeable future without
the need or intention to stop operation. If there is significant doubt that
the business will continue in operations (“Going Concern Problem”), the
going concern assumption is foregone and financial statements will be
prepared under a TERMINATING CONCERN basis.
2. The Accounting Entity Concept

 An entity is an object of accounting. Accounting presents financial

information regarding an entity. An entity can be a business, a person, an
organization or the government.
 A business is a separate accounting entity from its owners. Hence, in
preparing financial reports about the business, transactions of the owners
are excluded.
3. Periodicity Assumption/Accounting Period Assumption

 The periodicity assumption is an offshoot of the going concern assumption.

The presumed indefinite life of the business is broken into
distinct equal periods called “accounting period” over which the
financial performance and financial condition of the business are accounted
and reported to users of the financial statements.

 Income is not measured from the start-up of business up to its dissolution

but is rather reported every accounting period.

 The length of the accounting period can either be weekly, monthly,

quarterly, semi-annually, or annually.
4. Accrual Basis
 The concept of accrual is also an offshoot of the accounting period assumption.
Under the accrual method, income are recorded in the accounting period
they are earned regardless of when they are collected whereas
expenses are recorded in the period incurred regardless of when they
are paid.
 The accrual basis or method of reporting income or expenses has the following
terms:
a) Accrued Income – an income that is already earned but is not
yet collected
b) Accrued Expense – an expense that is already incurred but not
yet paid
c) Deferred Income – an income that is already received but not
yet earned
d) Prepaid Expense – an expense that is already paid but not yet
incurred
5. Monetary or Measurement Concept

 Only financial transactions are recorded and reported in terms of

money such as the PESO. Nonfinancial information is not recorded but
information relevant to users of financial statement is noted via a memo
entry in the books.
6. Realization Concept
 Income is recognized when realized or earned. Income is said to be realized when
one of the contracting party performed his obligation on the contract, thud have
established a right to demand from the other party.
 Realization of income from sale of goods
o The ownership to the goods transfers to the customer depending on the
following shipping terms:
a) Freight on board (FOB) Shipping point- ownership of the goods
transfers to the buyer the moment goods leaves premises of the seller.
b) Freight on board (FOB) Destination- ownership of the goods transfers to
the buyer the moment goods arrive at the buyer’s warehouse.
 Realization of income from sale of services
o Income from sale of services is realized when services are rendered based on
the extent of completion.
7. Matching Concept
 The matching concept relates to the timing of recognition of an expense. It postulates
that expenditures shall be expensed in the accounting period the benefits of the
expenditure are realized by the entity. An expenditure is an outflow of resources or an
obligation requiring futureoutflow of resources.
 Types of expenditure:
a) Capital expenditures- expenditures that benefits future accounting period. These
are to be recorded as ASSETS.

Example: of this is the purchase of a building. Building can be utilized or more than one accounting period.
Thus, it is to be recorded as an asset.

b) Period expenditures-expenditures that benefits only the current accounting

period. These are to be recorded as EXPENSES.

An example of this is pens purchased. Generally, pens are

only to be utilized in one accounting period that qualifies it to be recorded as expense instead of asset.
8. Cash Basis of Accounting
 This is the opposite of Accrual Basis of Accounting. Under this
method, income is recorded when collected regardless of when earned
while expense is recorded when paid regardless of when it isincurred.

9. Duality Concept
 In accounting, each transaction is portrayed as a two-ford effect on the
elements of financial statements This is one of the mostimportant basic
accounting concepts you must appreciate.
Other Accounting Concepts
10. Conservatism
 This is also known as prudence. In case of doubt, assets and income
should not be overstated while liabilities and expenses should not be
understated.

11. Disclosure principle

 This states that all relevant and material information should be reported.

12. Objectivity principle

 Financial statements must be presented with supporting evidence.
13. Monetary unit principle
 Amounts are stated into a single monetary unit

14. 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 of this is when 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.
15. Terminating Concern
 With the support of strong evidence, the business assumes that the
business will cease its operations. Hence, the going concern cannot be
applied.

16. Historical Cost Concept

 Fixed assets must be reported in the financial statements on the cost on
which they were purchased. Fixed assets should not be recorded on their
market value unless especially when applying going concern principle
Activity Q1-01
Read the problem carefully. Indicate which accounting concept and principles
violated. Support your answer by giving your analysis.

Mr. Camacho, an owner-manager of Muscle

Mass Fitness Gym bought a motorcycle for
personal use. The invoice was given to his
accountant who recorded it as an asset of the
business.
Sweet Foods Company ordered supplies needed in
the assembly line of its production department.
Upon order, the supplies immediately recorded as
operating expenses.
XYZ Corporation is an owner of the ABC Gasoline
Station at the same time an
operator of the QRS Bus Liner. Some of the expenses
of QRS Bus Liner are reported to the ABC Gasoline
Station to increase their expenses and minimize their
taxes.
A heavy duty stapler purchased at a cost of
P500. This was recorded as an asset and a
depreciation expense to decrease its value
by P50 per year for 10 years.
In the Balance Sheet of Japon Surplus, an equipment
purchased from Japan for 200,000 yen was reported
while all other assets were reported in Philippine peso.
ELEMENTS OF FINANCIAL
STATEMENTS
An account is the basic storage of information in accounting. It is a record of
the increases and decreases in a specific item of asset, liability, equity, income
or expense. An account may be depicted though a “T-account”.

The Five Major Accounts/ Elements of Financial Statements

1. Assets
2. Liabilities
3. (Owner’s) Equity/net assets/ Capital
4. Income
5. Expenses
Assets
- the resources you control that have resulted from past events and can
provide you with future economic benefits, which may include:
(a) Sold or exchanged for other assets;
(b)Use singly or in combination with other assets to produce goods for sale;
(c) Used to settle a liability;
(d) distributed.

Liabilities
-are your present obligations that have resulted from past events can require you to
give up resources when settling them.
(Owner’s) Equity/net assets/ Capital-assets minus liabilities

Income
-are increases in economic benefits during the period in the form of
inflows or enhancements of assets or decreases of liabilities that result in
decrease in equity, other than those relating to investments by the business
owners.
o includes both revenue and gains
a) Revenue arises in the course of ordinary activities of a business and is
referred to by a variety of different names including sales, fees, interest,
dividends, royalties, and rent.
b) Gains represent other items that meet the definition of income and may or
may not rise in the course of the ordinary activities of an economic entity.