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Accounting Concepts
and Principles

Fundamentals of Accountancy, Business and Management 1

Mica Collen P. Isidro 1

SENIOR HIGHSCHOOL FABM 1
 TOPIC OR
Module 2: Accounting Concepts and Principles
LESSON NAME
The learner demonstrates understanding of
CONTENT
STANDARDS  accounting concepts and principles

The learner is able to

PERFORMANCE
STANDARDS  identify generally accepted accounting principles

MOST The learners shall be able to:

ESSENTIAL
LEARNING  explain the varied accounting concepts and principles
COMPETENCIES  solve exercises on accounting principles as applied in various cases

TIME
4 hours
ALLOTMENT
1.

ACCOUNTING CONCEPTS AND PRINCIPLE

Accounting assumptions are concepts or principles in the preparation of financial statements

Financial statements are prepared on the assumptions that the entity will
continue in operation into the foreseeable future without the need or
intention to stop operation. As such, the resources to be realizable and the
obligations of the business are presumed payable in the normal course of
business.

If there is significant doubt that the business will continue in operations

(“Going concern problem”), the going concern assumption is forgone and
financial statements will be prepared under a Terminating concern basis.
Under this basis, the historical cost valuation is abandoned. The resources and obligation of the entity are re-
measured to estimate realization value and estimated settlement value, respectively.

Illustration:
ABC Proprietorship purchased an equipment with a purchase cost of ₱100,000. The equipment can be sold for
₱70,000 if the company is liquidated.

The equipment shall be presented as ₱100,000 in the accounting books if the business expects to continue in
operation and recovers or realizes the value of the equipment through use in the normal course of business
without the need of recovering the same through sale.

If the business is expected to terminate, it shall forgo the ₱100,000 valuation and re-state its equipment to a
₱70,000 valuation because it is the most relevant mode of realization of the asset.
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 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 entry from its owners. Hence,

in preparing financial reports about the business, transactions of
the owners are excluded.

Illustration:
A businessman sets-up a merchandising business by investing
₱100,000 cash to the business. He used the ₱80,000 cash to
purchase goods for sale, and used the rest to pay ₱10,000 rent of
the business premises, ₱10,000 for local business taxes. He also paid ₱5,000 tuition fee of his children, ₱10,000
salaries of his household help and sold his car for ₱150,000 earning him ₱15,000 gain.

In reporting for the business entity, only transactions pertaining to the business shall be recorded, such as the
following:
a. Purchase of ₱80,000 goods
b. Payments for ₱10,000 rent
c. Payment for ₱10,000 local business taxes

The following are non-business related transactions (i.e. personal transactions) and are not to be recorded in
the accounting records of the business:
a. Payment of ₱5,000 tuition fees
b. Payment for ₱10,000 household salaries
c. Sale of personal car

The periodicity assumption is an offshoot of the going concern

assumption. The presumed indefinite life of the business is broken into
distinct equal time 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 to its dissolution

but is rather reported every accounting period.

The length of the accounting period can either be:

1. Weekly
2. Monthly
3. Quarterly
4. Semi-annually, or
5. Annually

The business regularly reports its financial position and

performance at the end of its accounting period.

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 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 expense 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 income – an expense that is already paid but not
yet incurred

Example 1 – Earning of uncollected income

DEF Company rendered rental accommodation services priced at ₱20,000 to a client in year 2019. The rental
will be paid by the client in 2020.

Under the accrual basis, ₱20,000 shall be recognized (recorded) as rental income in the Year 2019, not in the
year 2020, because the same is earned in 2019. This is called accrued income.

Example 2- Incurring an unpaid expense

James Enterprise pays employee salaries on the 3rd and 18th day of the month. James Enterprise shall pay
₱30,000 salaries on July 3 next month.

James Enterprise shall split the ₱30,000 salaries expense as follows:

Expense Days Computation Amount

For June June 19 to June 30 12 days / 15 days x ₱30,000 ₱ 24,000
For July July 1 to July 3 3 days / 15 days x ₱30,000 6,000
₱ 30,000
James Enterprise shall record a salaries of ₱24,000 in June even if the same is not yet paid because the same
is already incurred in June. This is called accrued expense. The other ₱6,000 shall be recorded as expense in
July.

Example 3 – Receipt of unearned income

Mr. Lessor reports statements annually using the calendar accounting period. He received ₱120,000 advanced
rental from a lessee for one year covering October 1, 2019 to September 30, 2020.

At December 31, 2019, the ₱120,000 advanced rental shall be split as income as follows:

Expense Days Computation Amount

For the Year 2019 Oct. 1 to Dec. 31, 2019 3 mons. / 12 mons. x ₱120,000 ₱ 30,000
For the Year 2020 Jan. 1 to Sept. 30, 2020 9 mons. / 12 mons. x ₱120,000 90,000
₱ 120,000

Only ₱30,000 shall be recognized as rental income in Year 2019 because the same is earned in 2019. The
₱90,000 portion of the advanced income shall be considered as a liability or debt (i.e. unearned income) because
it is not yet earned.

Example 4 – Payment for advance expense

HIJ Enterprise paid ₱15,000 for one-year fire insurance of its building covering August 1, 2019 to July 30, 2020.

At December 31, 2019, the ₱15,000 payment must be analyzed for its expired (expense) and unexpired
component.

Expense Days Computation Amount

For the Year 2019 Aug. 1 to Dec. 31, 2019 5 mons. / 12 mons. x ₱15,000 ₱ 6,250
For the Year 2020 Jan. 1 to Jul. 31, 2020 7 mons. / 12 mons. x ₱15,000 8,750
₱ 15,000

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Only the ₱6,250 expired portion of the ₱15,000 prepaid expense is an expense in 2019. The unexpired balance
of ₱8,750 is still an asset (i.e. Prepaid Insurance) in 2019.

GAAP requires that income is recognized in the accounting period

earned while expense is recognized in the accounting period
incurred.

Only financial transactions are recorded and reported in terms

of money such as the Peso. Non-financial information is not
recorded but information relevant to users of financial
statements is noted via memo entry in the books.

Only transactions or events that pertain to the business entity are

recorded.

Illustration:
The business paid ₱10,000 for business licenses. 3 days later, the business registration was complete. The
business then executed a contract to lease a commercial space for ₱20,000 a month. Two days later, the
business paid ₱40,000 advanced rental deposit.

Only the following monetary transactions shall be recorded:

a. Payment of ₱10,000 business expense, not the completion of business registration
b. The payment of ₱40,000 advanced rental not the contract signing for the lease contract.

The following non-monetary transactions are not recorded:

a. Completion of business registration
b. Execution of lease contract

OTHER ACCOUNTING CONCEPTS

1. Realization concept
2. Matching concept
3. Duality concept

Income is recognized when it is realized or earned. Income is said to

be realized when one of the contracting party performed his obligation
on the contract, thus have established a right to demand from the party.

Realization of income from sale of goods

Income from the sale of goods is realized when ownership to the goods
passes to the customer.

The ownership to the goods is realized when ownership to the goods

passes to the customer.
a. FOB Shipping point – ownership to the goods transfer to the buyer at the moment the goods leaves the
premises of the seller
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 b. FOB Destination – ownership to the goods transfer to the buyer upon arrival at the warehouse of the
buyer.

Realization of Income from sale of services

Income from the sale of services is realized when services are rendered based on the extent of completion.

The matching concept related to the timing of recognition of an expense. It

postulates that expenditures shall be expensed (i.e. matched with income) 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 future outflow
of resources.

Types of expenditure:
1. Capital expenditures – these are expenditures that benefits future accounting periods. These are
recorded in accounting as assets.
2. Period expenditures – these are expenditures that benefits only the current period. These are recorded
as expense.

Example of capital expenditures:

a. Supplies
b. Inventory
c. .Equipment
d. Land
e. Building
f. Prepaid expense

Examples of period expenditure:

a. Salaries
b. Utilities
c. Rent
d. Interest
e. Cost of sales

Recognition of expenses
Expenses are recognized in the income statement when a decrease in future economic benefits related to a
decrease in an asset or an increase of a liability has arisen that can be measured reliably. This means, in effect,
that recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease
in assets (for example, the accrual of employee entitlements or the depreciation of equipment).

Expenses may be recognized using:

a. Direct association or matching of cost against the revenues or Cause and effect association
b. Systematic and rational allocation
c. Immediate recognition

Expensing of capital expenditures

a. Direct association or matching of cost against the revenues or Cause and effect transaction –
expenditures that are directly associated with an item of income are recognized as expense in the period
the income is realized.
b. Systematic and rational allocation – if the expenditure benefits several accounting periods, the cost of
capital expenditure is spread as expense over the period it is benefited.

Properties held for use by the business such as building, machineries, equipment and improvements are
initially recorded as assets upon acquisition. These assets are usually used over long periods of time, In
accounting, the cost of these assets is spread over as expense over the period they are expected to be
used.

c. Immediate recognition – expenditures that cannot be associated to a particular income and has no
expected future economic benefits are recognized outright as expense in the year incurred.

Illustration: Direct association or matching of cost against the revenues or Cause and effect association

Examples:
1. Goods purchased are expensed as “cost of sales” in the period the sales income is recognized.

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 2. Sales agent’s commission expense is recognized when the related sales is reported as income.
,
Illustration: Systematic and rational allocation

Example 1 – Items of properties, plants and equipment

In January 1, 2019, ABC Company acquired a piece of equipment for ₱40,000 cash. The equipment is expected
to serve the company for 5 years after which it can be sold at scrap value of ₱10,000.

Cost of the asset ₱ 40,000

Less: Salvage or scarp value of asset 10,000
Expected decrease in value through usage (depreciable cost) ₱ 30,000

The depreciable cost shall be spread as expense called “depreciation expense” over the expected useful life of
an asset. The annual expense shall be ₱6,000 computed as (₱30,000/5 years). The remaining unexpensed
portion of the depreciable cost is an asset.

Example 2 – Supplies
In July 1, 2019, ABC paid worth ₱30,000 supplies. Supplies worth ₱8,000 was used in 2019 while the rest was
used in 2020.

The ₱8,000 supplies shall be recognized as “supplies expense” in 2019 while the ₱22,000 shall be recognized
as “supplies expense” in 2020.

Illustration: Immediate recognition

Expenses that have no proximate future economic benefits are recognized as “expense” in the period they are
incurred.

Examples:
1. Cost of administering the business such as salaries and advertising
2. Interest expense and utilities expense
3. Loss on the destruction of an asset

Non-expenditures can never be expense

Returns of claims are not expenditures and will never be recognized as expense, such as the following:
a. Repayments of debts
b. Return of capital to owners or equity participants
c. Distributions of income to owners or equity participants.

Accounting matches expenses with income.

There is also another accounting method for income and expense called
the CASH 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 is incurred.

Accrual Basis vs. Cash Basis of Accounting

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 – In accounting, each transaction is portrayed as a two-fold effect on at least two
elements of financial statements. This is one of the most important basic accounting concepts you must
appreciate.

This two-fold effect is recorded in the accounting books as a debit and a credit entry in the accounting books.

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