Underlying Assumption/Fundamental Concepts

Going Concerns- In the foreseeable future a company will continue operating. If this assumption
is not true, deferred expenses should be recognized at once (as when bankruptcy appears likely).
This assumption underlies the depreciation of assets over their useful lives.
Ex: The National company is in serious financial trouble and cannot pay its obligations. The
government gives National company a bailout and a guarantee of all payments to creditors. The
national company is a going concern despite of its current weak financial position.

Accounting Entity/Economic Entity Principle - The transactions of a company and its owners
are not mixed. It is impossible to prepare accurate financial statements if this assumption is not
true. For small family businesses, this assumption is a particular problem. Each entity should be
evaluated separately.
Ex: The owner of a business loans $100,000 to his company. This is recorded by the company as
a liability, and by the owner as a loan receivable.

Time Period/Periodicity Concept- The financial results published by an enterprise should cover
a clear and consistent duration. Unless this is the case, the financial reports are not comparable
throughout the reporting periods. This concept allows the users to obtain timely information to
serve as a basis on making decisions about future activities.
Ex: The companies reporting period for the current year is set at calendar months, then the same
periods should be used in the next year, so that the results of the two years can compared on a
month-to-month basis.

Stable Monetary Concept-The principle of the monetary unit states that you record only
business transactions which can be expressed in currency terms. A company can therefore not
record non-Quantifiable items such as employee skill levels, customer service quality or
engineering employee ingenuity.
The principle of monetary unit also assumes that the value of the currency in which your
transactions are recorded remains relatively stable over time. However, this assumption is not
correct given the persistent inflation of the currency in most economies.
Ex: The dollar that the purchasing power of the dollar has decreased over the interim years is
significantly higher than that which was invested today for the 20-year period. If an entity records
the transactions in a worldwide economic economy monetary unit, the assumption will fail
completely. If deflation occurs, the financial statements of a company must regularly be restated.
 Criteria for GAAP

GAAP are the concepts, standards, and rules that guide the preparation and presentation of
financial statements. They are a set of accounting principles and financial reporting practices
generally followed. Including definition of concept and theory, and even industry-specific
regulations, the GAAP requirements, the standard adopted by the US Securities and Exchange
Commission (SEC). The GAAP seeks to ensure accountability and continuity in financial reporting
between organizations. The general acceptance of an accounting principle usually depends on how
well it meets criteria relevance, objectivity, and feasibility.

Relevance- Relevance relates to the importance of the knowledge for financial decision-making.
It must have Confirmatory value, and Predictive value in order for the information to be relevant.

 Confirmatory value – Offers past events information

 Predictive value – offers the capacity to predict future events

Objectivity- The concept of objectivity states that accounting and financial statements shall be
autonomous and impartial evidence. This means that the details on accounting should be focused
not only on a prepared opinion but on analysis and evidence. The concept of objectivity seeks to
increase the relevance and reliability of financial reports.

Feasibility- It is an analysis that takes into account all applicable project factors – including
economic, technological, legal and scheduling considerations – to determine the probability of
successful project completion. Project managers use feasibility studies to distinguish the benefits
and drawbacks of a project before spending a lot of time and resources
Feasibility may also provide valuable knowledge for a company's management to discourage a
firm from joining risky businesses blindly.
 Measurement Principles

GAAP generally uses one of two measurement principles, the historical cost principle or the fair
value principle. Selection of which principle to follow generally relates to trade-off s between
relevance and faithful representation. Relevance means that financial information is capable of
making a difference in a decision. Faithful representation means that the numbers and descriptions
match what really existed or happened—they are factual.

Measurement is defined as quantifying in monetary terms the elements in the financial statements.

Relevance and faithful representation are two primary qualities that make
accounting information useful for decision-making.

Historical Cost Principle

The historical cost principle (or cost principle) dictates that companies record assets at
their cost. This is true not only at the time the asset is purchased, but also over the time the asset
is held.
 This principle states that acquired assets should be recorded at their actual
cost and not at what management thinks they are worth as at reporting date.
For example, if Robinsons purchases land for P 900,000, the company initially reports it
in its accounting records at P 900,000. But what does Robinsons do if, by the end of the next year,
the fair value of the land has increased to P 1,200,000? Under the historical cost principle, it
continues to report the land at P 900,000.

Fair Value Principle

The fair value principle states that assets and liabilities should be reported at fair value (the price
received to sell an asset or settle a liability). Fair value accounting uses current market values as the
basis for recognizing certain assets and liabilities.
Fair value is the estimated price at which an asset can be sold or a liability settled in an orderly
transaction to a third party under current market conditions.

 Fair value information may be more useful than historical cost for certain
types of assets and liabilities.
 For example, certain investment securities are reported at fair value because market price
information is usually readily available for these types of assets.

Selecting a Measurement Basis

In determining which measurement principle to use, companies weigh the factual nature of
cost figures versus the relevance of fair value. It is necessary to consider the nature of the
information that the measurement basis will produce.
 In most cases, no single factor will determine which measurement basis should be selected.
 The relative importance of each factor will depend on facts and circumstances.
 The information produced by the measurement basis must be useful to the users of financial
information
To achieve this, the information must be both relevant and faithfully represented. In general,
most companies choose to use cost. Only in situations where assets are actively traded, such
as investment securities, do companies apply the fair value principle extensively.

Basic Principles

In order to generate information that is useful to financial statements, accountants rely upon
the following principles:

Objectivity Principle
Accounting records and statements are based on the most reliable data available so they will
be acute and useful as possible. Reliable data are verifiable when they can be confirmed by
independent observers. Ideally, 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 and is therefore subject to disputes.

 The Monsato Company based in the United States of America, violated accounting rules
and the objectivity principle in 2016, by misstating the earnings of the company through
internal accountants. The violation led to the firm paying an $80 million penalty.
 The objectivity principle states that the financial statements of a company produces must
be based on solid evidence. However, Monsato company made their own way and created
personal biases in their financial statements.
 Revenue Recognition Principle

Revenue is to be recognized in accounting period when goods are delivered or services are
rendered or performed.
 Labada Ko completes the laundry service they made for Magisson Hotel for P 50,000. It
can recognize the revenue immediately upon the completion of service, even if it does not
expect payment from Magisson Hotel for several weeks.

Expense Recognition 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.

 For example, a business pays $100,000 for merchandise, which it sells in the following
month for $150,000. Under the expense recognition principle, the $100,000 cost should
not be recognized as expense until the following month, when the related revenue is also
recognized. Otherwise, expenses will be overstated by $100,000 in the current month, and
understated by $100,000 in the following month.

Adequate Disclosure

Requires that all relevant information that would affect the user`s understanding and
assessment of the accounting entity be disclosed in the financial statements.

 At the end of the period, when XYZ Company was physically counting its inventories, it
was found out that $400 worth of their supply was missing. This discrepancy must be
properly disclosed in their financial statements to properly account the loss and do not
cause understatements.
 Materiality
Financial Reporting is only concerned 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 circumstances of its omission. In deciding whether an item or an aggregate items is a
material, the nature and size of the item are evaluated together. Depending on the circumstances,
either the nature or the size of the item could be the determining factor.

 For instance, if a minor item has the impact of changing a profit figure into a loss figure,
then it will be considered material regardless of how small the amount is. Similarly, if by
including a transaction, a ratio that needs to comply with changes, it would be considered
material.

Consistency Principle
The firm should use the same accounting period from period to period to achieve
comparability within a single enterprise. However, changes are permitted if justifiable and
disclosed in the financial statements.

 Apple Computers has been using the First in First Out (FIFO) method for valuing its
inventory. In the recent years, Apple Computers has become quite large and profitable. A
consultant advises Apple to change its inventory valuation method to Last in First Out
(LIFO) to minimize the taxable income. As per the consistency principle, the company can
only do this if it has a justifiable reason and whether or not reducing the tax bill is justifiable
is debatable (You will learn more about inventories when you tackle accounting for
merchandising business).
 Sources:

Bragg, S. (2020, December 19). Fair value accounting. Retrieved March 01, 2021, from
https://www.accountingtools.com/articles/fair-value-accounting.html

Bragg, S. (2020, December 13). Expense recognition principle. Retrieved March 01, 2021, from
https://www.accountingtools.com/articles/expense-recognition-principle.html

Consistency principle: Importance, advantages, examples. (2020, October 22). Retrieved March
01, 2021, from https://studyfinance.com/consistency-principle/

Materiality concept: General rule, example, abuse of materiality. (2020, October 22). Retrieved
March 01, 2021, from https://studyfinance.com/materiality-concept/

Objectivity principle: Examples, advantages, disadvantages, conclusion. (2020, October 22).

Retrieved March 01, 2021, from https://studyfinance.com/objectivity-principle/

Weygandt, Jerry J, Kimmel, Paul D.,Kieso, Don E; Accounting Principles, 2016

Valix, Peralta and Valix, 2020, Conceptual Framework and Accounting Standards
Ballada, Ballada, 2021, Basic Financial Accounting and Reporting