Topic 3: Accounting Concepts and Principles

Generally Accepted Accounting Principles (GAAP)

⚫ These are general, broad statements or “rules and procedures” that
serve as guides in the practice of accounting.
⚫ These are standards, assumptions, and concepts with general
acceptability.
⚫ These are measurement techniques and standards used in the
presentation and preparation of the financial statements.
⚫ They serve as the foundation of accounting in order to avoid
misunderstanding and enhance the understandability and usefulness of
the financial statements (Valix et. al, 2013 as cited in Florendo, 2016)

Fundamental Concepts
1. Business Entity Concept

⚫ An accounting entity is an organization or a section of organization that

stands apart from other organizations and individuals as a separate
economic unit. (e.g. the owner, managers, or employees are all
separate and distinct from the business)
⚫ The transactions of different entities should not be accounted for
together. Each entity should be evaluated separately.
Examples:
1. If the owner has a barber shop, the cash of the barber shop should be
reported separately from personal cash.
2. The owner had a business meeting with a prospective client. The expenses
that come with that meeting should be part of the company’s expenses. If
the owner paid for gas for his personal use, it should not be included as
part of the company’s expenses.
2. Periodicity
⚫ An entity’s life can be meaningfully subdivided into equal time periods for
reporting purposes.
⚫ Allows the users to obtain timely information to serve as a basis on making
decisions about future activities.
⚫ Usual accounting period is one year.
⚫ The accounting period can be classified as either of the following:
➢ Calendar Year
- A twelve-month period that’s starts on January 1 and ends
on December 31.
➢ Fiscal Year
- A twelve-month period that starts on any month of the year
other than January and ends twelve months after the
starting period, e.g., a business whose fiscal year starts May
1, 2006 ends its fiscal year on April 30, 2017.
▪ Note: A natural business year is any twelve-
month period that ends when business
activities are at the lowest point.
⚫ Examples:
- Philippine companies are required to report financial
statements annually.
- The salary expenses from January to December 2015 should
only be reported in 2015.

3. Stable Monetary Unit Concept

⚫ The Philippine peso is a reasonable unit of measure and that its
purchasing power is relatively stable.
⚫ Allows accountants to add and subtract peso amounts as though each
peso has the same purchasing power as any other peso at any time.
Examples:
1. Furniture purchased during the year 1990 for a cost of 10,000 pesos is
presented in the Financial statements together with Furniture bought for
100,000 pesos in 2021
2. A 100 sq.m Land bought during 1970 for 10,000 is presented together with
a 100sq. m land found in the same area bought during 2022 for 1,000,000
4. Accrual Basis
⚫ Accrual accounting depicts the effects of transactions and other events
and circumstances on a reporting entity’s economic resources and
claims in the periods in which those effects occur, even if cash receipts
and payments occur in a different period.
⚫ Revenue should be recognized when earned regardless of when
collection is done and expenses should be recognized when incurred
regardless of when payment is made.
⚫ On the other hand, the cash basis principle in which revenue is recorded
when collected and expenses should be recorded when paid. Cash
basis is not the generally accepted principle.
Examples:
1. When a barber finishes performing his services he should record it as
revenue even if it is on credit.
2. When the barber shop receives an electricity bill, it should record it as an
expense even if it is unpaid.

5. Going Concern
⚫ The financial statements are normally prepared on the assumption that
an enterprise is a going concern and “will continue in operation for the
foreseeable future.”

Basic Accounting Priciples

- The set of guidelines and procedures that constitute acceptable
accounting practice at any given time is GAAP (Generally Accepted
Accounting Principles). In order to generate information that is useful to the
users of financial statements, accountants rely upon the following principles:

1. Objectivity Principle
⚫ Accounting records and statements are based on the most reliable data
available so that they will be as accurate and useful as possible.
⚫ Reliable data are verifiable when they can be confirmed by
independent observers.
⚫ Accounting records are based on information that flows from activities
documented by objective evidence.
⚫ Without this principle, accounting records would be based on whims and
opinions, therefore, subject to disputes.
Example:
⚫ Utility expenses should be supported by Statement of Account from Utility
companies like CENECO and BACIWA.
⚫ Payments for the business should be supported by an Official Receipt
issued by the supplier or vendor.

2. Cost Principle
• Also known as the Historical Cost principle.
• Acquired assets should be recorded at their actual cost and not
what the management thinks they are worth as at reporting date.
Amounts are not adjusted upward for inflation.
• All assets acquired should be valued and recorded based on the
actual cash equivalent or original cost of acquisition, at the time of
purchase, not the prevailing market value or future value.
• Example:
o Bilis Serbisyo Repair Shop bought one computer unit for
Php 42,000, but it could have been purchased at Php
40,000 from another vendor. The shop should record the
transaction at Php 42,000 because that is the amount
given in exchange for the computer unit.
o Land bought in 2010 for 1,000,000 can now be sold for
2,000,000 in 2022. The land should still be recorded at
1,000,000 in the books of accounts in 2022 under this
principle
3. Revenue Recognition Principle

• Revenue is to be recognized in the accounting period when goods

are delivered, or services are rendered or performed, regardless of
when the cash is received.
• Example:
o On June 25, Bilis Serbisyo Repair Shop rendered service to
a client for Php 15,000. The service fee was collected on
 July 4. The entity should record the revenue of Php 15,000
in June, the time the service was rendered to the
customer, and not the time the money was received.
4. Expense Recognition Principle

• Also known as the Matching Principle.

• Expenses should be recognized in the accounting period in which
goods and services are used up to produce revenue and not when
the entity pays for those goods and services. This means that in a
given accounting period, the revenue recorded should have an
equivalent expense, recorded, in order to show the true profit of
the business.
• Examples:
o Sales salaries expense should be reported in the period
when the sales were made (and not reported in the
period when the salaries were paid).
o Wages to Bilis Serbisyo employees are reported as an
expense in the week when the employees worked and
not in the week when the employees are paid.
o Electricity consumed in December 2015 paid on January
7, 2016 should be reported as utility expense in the 2015
Income Statement and the unpaid amount at
December 31, 2015 should be reported as a liability in the
Balance Sheet.
5. Adequate Disclosure
• Also known as Full Disclosure Principle.
• Requires that all relevant information that would affect the user’s
understanding and assessment of the accounting entity be
disclosed in the financial statements.
• If certain information is important to an investor or lender using the
financial statements, that information should be disclosed within
the statement or in the notes to the statement.
6. Materiality
• Financial reporting is concerned only with information that is
significant enough to affect evaluations and decisions.
• Materiality depends on the size and nature of the item judged in
the particular circumstance of its omission. In deciding whether an
item is material, the nature and size of the item are evaluated
together. Depending on the circumstance, either the nature or the
size of the item could be the determining factor.
• Example:
o Php 10,000 might be immaterial to Ayala Corporation but
the same figure might be quite material for small
businesses like Bilis Serbisyo Repair Shop.
o Company XY purchased a paper puncher worth Php 300
with a useful life of 5 years. The materiality guideline
allows this company to violate the matching principle
and to expense the entire cost of Php 300 in the year it is
purchased. The justification is that no one would consider
it misleading if the Php 300 is expensed in the first year
instead of Php 60 being expensed in each of the 5 years
that it is used.
7. Consistency
• Firms should apply the same accounting method from period to
period to achieve comparability over time within a single
enterprise.
• However, changes are permitted if justifiable and disclosed in the
financial statements.