GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

▪ Are ground rules that govern how accountants measure, process, and communicate financial
information

▪ encompass the conventions, rules and procedures necessary to define what is accepted
accounting practice (Valix, Peralta & Valix, 2011)

▪ Ensures that financial statements are useful and meaningful.

▪ Allows financial statements to be compared

▪ Across different companies

▪ Own financial statement from period to period

A. Underlying Assumptions
1) ENTITY/ ECONOMIC ENTITY/ SEPARATE ECONOMIC ENTITY
• An entity is the organizational unit for which accounting records are maintained
• Assumes that the business is separate from its owners
• Activities of the entity must be kept separate and distinct from activities of the owner and
all other economic entities.
• Business Transaction- an economic event that can be measured in terms of money and
affects the enterprise.

2) GOING CONCERN

• In the absence of information to the contrary, this concept assumes that the business is to
continue its operations for an indefinite period of time.

• Continuity Assumption

• On the basis of this assumption, ASSETS and LIABILITIES are classified as either current or
non-current.

• Permits businesses to report ASSETS at their HISTORICAL COST

• However, if there is evidence that the business will not continue to operate in the indefinite
future, the going concern assumption is not appropriate.

• LIQUIDATING CONCERN- appropriate assumption when the business will not continue to
operate and instead liquidate.
SCENARIO (GOING CONCERN)

Entity A violated some regulations which would require payment of large amounts of penalties as a form
of sanction. The owner of Entity A assesses that the penalties can be paid by the entity and will not
affect business operations.

• Entity B is faced with great financial difficulties, with maturing obligations that it cannot pay.
The owner of Entity B sees that the entity should declare Bankruptcy.

3) MONETARY UNIT

• Money is used as a unit of measure in preparing various financial reports of the entity.

• Enables accounting to quantify and measure economic events.

• Assumes that MONEY is a CONSTANT AND STABLE UNIT OF MEASURE OVER TIME (Ignores
the effect of Inflation)

4) TIME PERIOD/ PERIODICITY

• Assumes that the indefinite life of a business can be divided into separate artificial time
periods.

• Allows for a timely measurement of accounting information

• At the end of each time period, accounting reports, financial statements are prepared.

• In choosing an accounting period:

• Interim Period- accounting periods shorter than one year.

• Calendar Year- twelve-month period beginning January 1 and ending December 31

• Fiscal Year- twelve-month period that starts from any month other than January.

• Natural Business Year- length of fiscal period is determined by the nature of the
business and frequency of need for data.

B. General Principles

1) HISTORICAL COST/ COST

• Principle that requires assets to be recorded at their ACQUISITION COST.

• Once recorded, ASSETS will continue to be carried at cost, adjusted for depreciation if there
would be any, even if their fair market value differs.
SCENARIO (COST PRINCIPLE)

Last January 1, 2014, Alloysius bought a delivery van for his water refilling station at a cost of
P1,600,000. On December 31, 2015, the fair market value of the delivery van is P1,2000,000.

• The delivery van, is to be recorded on January 1, 2014 at its acquisition cost, P1,600,000.

• On December 31, 2015, it will still be shown at cost of P1,600,000 less any depreciation.

SCENARIO (COST PRINCIPLE)

Last January 1, 2014, Alloysius bought a delivery van for his personal use at a cost of P1,600,000. On
January 1, 2015, he decided to invest the delivery van in his water refilling station. At that time, the fair
market value of the van is P1,400,000.

• The delivery van, is not to be recorded on January 1, 2014 because it is for Alloysius’ personal
use.

• On January 1, 2015, the delivery van is to be recorded in the accounting books since it is now
invested in the business at its fair market value of P1,400,000

2) REVENUE RECOGNITION

• Revenue represents inflow of new assets resulting from sale of goods or services to an
outsider.

• Revenue should only be recorded in the period when it was earned or realized regardless
whether cash was received or not.

• When is revenue considered earned or realized?

• Services- when the service has been fully-rendered.

• Merchandise- when the goods were fully-delivered.

3) MATCHING PRINCIPLE

• Expenses represent outflow of resources incurred in generating revenues

• Costs or expenses incurred in earning revenues must be recorded in the same period in
which the related revenue was earned

• Implies a cause-and-effect relationship.

4) ACCRUAL BASIS OF ACCOUNTING

• Income is recorded when earned regardless whether cash has been received or not.

• Expense is recorded when incurred whether or not payment has been made.

ACCRUAL
BASIS

Revenue
Matching
Recognition

5) FULL DISCLOSURE

• Requires that all information that might affect the user’s interpretation and understanding
of the financial statements be disclosed.

• Disclosures may come in the form of:

• Parenthetical comments on the face of financial statements

• Disclosure Notes/ Notes to Financial Statement

C. Modifying Constraints

1) COST-BENEFIT

• The cost of gathering information to comply with an accounting principle or rule should be
justified by the benefit that would be provided if the preferred treatment is followed.

• Goes hand-in-hand with Materiality.

2) CONSERVATISM

• When uncertainties exist, accountants lean toward or favor the accounting method that
would produce the lower net income or lower asset valuation.

• In the presence of uncertainties, the accounting method with the least impact on equity is
preferred.
SCENARIO (CONSERVATISM)

Entity X is uncertain as to how specific Asset and Income items are to be measured, in the presence of
competing alternatives.

In the presence of uncertainty, an understatement of assets or income is preferred rather than an

overstatement.

3) INDUSTRY PRACTICE

• Some industries have unusual tax laws or regulatory requirements and have developed
special accounting principles and procedures for their industry.

• Example: Public Utility Companies

D. Qualitative Characteristics

1) USEFULNESS

• Information should be useful for decision-makers

2) UNDERSTANDABILITY

• Information should be presented in a clear and understandable manner, assuming users

have some basic knowledge of business and economics.

3) RELEVANCE

• Information should be appropriate for and have a bearing on decisions to be made by users.

• Timeliness- information should be reported promptly so that it can be useful in current

decision-making.

• Relevant information should have predictive value and feedback value.

4) MATERIALITY

• Refers to the relative importance or significance of an item in relation to a particular

situation or set of facts.

• An item is material, if knowledge of it, it’s inclusion or exclusion in the financial statements
will affect the decision of a prudent decision-maker.

5) RELIABILITY

• Information should be dependable, free from error and free from bias.
 • Verifiability- supporting documents support the amounts reported in the financial
statements and they are available for examination.

• Representation Faithfulness- data shown in the financial reports reflect what really
happened.

6) NEUTRALITY

• Information should not favor one group of users over another.

• Information should be helpful and useful to all groups of users.

7) COMPARABILITY

• Information should be presented so that it can be meaningfully compared with financial

statements of other businesses as well as previous financial statements of the business
itself.

8) CONSISTENCY

• Means that an entity uses the same accounting treatment for similar events and data from
period to period.

• Consistency permits comparability.