Republic of the Philippines

Department of Education
Cordillera Administrative Region
Division of Baguio City
BAGUIO CITY HIGH SCHOOL
SENIOR HIGH SCHOOL

Course Title: Fundamentals of Accountancy, Business and Management 1

LESSON 6: Accounting Concepts and Principles

Content Standards
Performance Standards
Learning Competencies
The learners demonstrate an understanding of accounting concepts and principles
The learners shall be able to identify generally accepted accounting principles (GAAP)
The learners:
1. explain the varied accounting concepts and principles
2. solve exercises on accounting principles as applied in various cases

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

The preparation of financial statements is governed and guided by Generally Accepted Accounting Principles (GAAP).
GAAP are uniform set of accounting rules, procedures, practices and standards that are followed in preparing the financial
statements. They serve as ‘ground rules’ that guide accounting practitioners in recording and reporting financial information of a
business entity.
The practice of accountancy profession is continually evolving and developing to meet the changing needs of the time. And
as time changes, new accounting principles emerge as business organizations enter into a new form of business entity.
Here in the Philippines, the development of GAAP is formalized through the creation of Philippine Financial Reporting
Standards Council (PFRSC), a standard-setting body with its pronouncement contained in the Philippine Financial Reporting
Standards (PFRS) used as the primary source of GAAP. The PFRS are patterned from the International Financial Reporting
Standards (IFRS) and International Accounting Standards Board (IASB). This means that the accounting standards used here in the
Philippines are similar to those used in other countries.

ACCOUNTING PRINCIPLES
1. Cost Principle
This principle requires that assets should be recorded at original or acquisition cost. Example, if we buy a land
today, say at a cost of 1 million pesos. Three years after, the current value of the land is approximately 2 million.
What will prevail in the record is the 1 million and not the 2 million because cost is definite and verifiable. The
value exchanged at the time land is acquired generally can be objectively measured.

2. Objectivity Principle
This principle requires that accounting records should be based on reliable and verifiable data as evidence of
transactions

3. Materiality Principle
This principle dictates practicability to rule over theory in determining the valuation of an item. To determine
whether the item is material or not, it is a matter of professional judgment on the part of the accountant.

4. Matching Principle
This is the combined concept of Revenue Recognition and Expense Recognition Principles. Revenue should be
recognized when earned and corresponding expenses should be recognized when incurred during the same
period as revenue is earned. Proper matching of revenue and expense are called for.

5. Consistency Principle
This principle requires that accounting methods and procedures should be applied on a uniform basis from
period to period to achieve comparability in the financial statements.

6. Adequate Disclosure Principle

This principle requires that financial statements should be free from any material misstatement; that if there is
any, proper disclosure should be made

BASIC ACCOUNTING ASSUMPTIONS

We should understand that the preparation of financial statements is guided by concepts or assumptions. Accounting
concepts or assumptions are the very foundation of GAAP. Without these accounting assumptions, there could be no uniformity in
the practice of accounting which can only result to having distorted and meaningless financial statements.

1. Accounting Entity

Also called ‘Business Entity Assumption’ or ‘Separate Entity Assumption’

This assumes that from the accounting point of view, the business is considered “an entity that is separate and
distinct from the owner or management.” When the owner puts in money, property or both into the business,
Lesson 6: Accounting Concepts and Principles 1
 these become “not his personal assets anymore but rather the assets of the business already.” In other words,
the ownership of the assets is shifted from the owner to the business. For this reason, a clear distinction between
business transactions and personal affairs must be established because only business transactions are recorded
in the books of the business. This enables the owner to properly determine whether his business is profitable or
not.

For example, Mr. Sean Jean, owns a laundry business named Super Clean Laundry Services. All cash and
properties that he puts into his business are now owned by ‘Super Clean Laundry Services’ and not by Mr. Sean
Jean anymore. In other words, the personal ownership has been transferred from Mr. Sean Jean to Super Clean
Laundry Services so that all his personal and family expenses such as food, clothing, salaries for his house
helpers, tuition fee, etc. should not be mixed up with business transactions and should be accounted for
separately from his business.

2. Going Concern Assumption

The business is assumed to have a continuous life of existence. It will continue to operate for an indefinite period
of time, so that financial statements are prepared in a going concern unless there is a specific evidence to the
contrary where departure from and abandonment of this assumption warrants. When business for example
suffered tremendous or persistent losses from its operations, has a difficulty of survival and to be liquidated soon,
this assumption is abandoned.

3. Time-Period Assumption

In relation to the going concern assumption and that the business is assumed to have a continuous life, it would
be impractical to wait for several years to prepare financial reports and statements. With this, the life of the
business is divided into equal periods wherein at the end of each period, the accountant prepares the financial
statements. The period being referred to is known as accounting periods.

Accounting periods can be:

1 Month – where financial statements are prepared at the end of every month. We call this on a
Monthly Basis. This is the shortest accounting period.

3 Months – where financial statements are prepared at the end of three months. We call this on a
Quarterly Basis.

6 Months – where financial statements are prepared at the end of every six months. We call this on a
Semi-Annual Basis or Semestral Basis.

12 Months – where financial statements are prepared at the end of every twelve months. We call this
on a Yearly or Annual Basis.

The length of accounting period chosen depends on the need of the owner for financial information about his
business. Most often, however, the business adopts an accounting period of one year. An enterprise may adopt
any of the given accounting period. The basic consideration in the choice of an accounting period is that th period
chosen must be reflective of the results of ‘normal operations.’

The accounting periods of less than one year is called ‘ interim period’ and the financial statements prepared are
being referred to as ‘interim financial statements.’

There are three annual accounting periods to choose from as far as periodic reporting is concerned, these are:

Calendar Year – the accounting period will begin on January 1 and will end on December 31 of the same year.
This is the most common accounting period that the business adopts because this is the nearest accounting
period wherein business entities file their Income Tax Returns. The business records are closed on December 31
and the deadline for filing tax returns is April 15 of the next year. There are 4 quarters in a calendar year
consisting of 3 months each. The first quarter covers from January 1 to March 31; second quarter from April 1 to
June 30; third quarter from July 1 to September 30; and the fourth quarter from October 1 to December 31.

Fiscal Year – the accounting period will begin on the first day of any month of the year except January and will
end on the last day of the twelfth month completing the 1-year period. Example, if the period begins on June 1 of
the current year, it will end on May 31 next year. This is used by businesses to coincide with their operating
cycle. Schools for instance may use fiscal year as the school year starts in June and ends in May of the next
year.

Natural Year – this is a twelve-month period that ends on any month when the business is at the lowest or
experiencing slack season. Example, a natural business year for the hotel industry starts at that point of slack in
visitors and ends up at its peak season.

4. Monetary Unit Assumption

Lesson 6: Accounting Concepts and Principles 2

 This assumes that in the Philippines we use the peso as a unit of measure. This unit of measure is assumed
further to have a stable value which means that purchasing power of the peso is constant regardless of inflation
rates or fluctuation in money values. In this, the function of accounting is ‘to account for peso only and not for
changes in its purchasing power.’ The other term used for this assumption is “Stable Monetary Unit” or
“Monetary Convention.”

For examples, the business enterprise has a foreign currency on hand; say US dollars, when financial statement
is prepared. The US dollars should be converted into its peso equivalents based on the prevailing exchange
rates as of Balance Sheet date.

5. Accrual Basis

This assumes that the recording of income and expense follow the accrual basis of accounting. Under accrual
basis, income is recognized when earned regardless of when received and expense is recognized when incurred
regardless of when paid. In other words, the essence of accrual basis of accounting is the recognition of
accounts receivable, accounts payable, prepaid expenses, accrued expenses, deferred income and accrued
income. This practice results to a proper matching of revenue and costs and expenses and could therefore show
correct and meaningful financial statements.

For example, Golden Transport Services received a rental bill for a space of the building it occupies in the
amount of P10,000 for the month of March. Even if such bill will not be paid during the month, it must be record
Rent Expense because it has been incurred and a corresponding liability account should be set up by Golden
Transport Services.

In contrast, cash basis of accounting recognizes income only when actual cash is received and recognizes
expenses only when actual cash is paid.
Illustrative Example:

Mrs. Fely Tapia sells toiletries (perfumes, shampoo, soaps, etc.) from a Direct Selling Company to her
customers. The table below shows the details of her transactions for the month of November 2016.

Customer’s Name Amount Items Delivered Payment Received

(Yes or No) (Yes or No)
Kylie Versoza 15,000 Yes Yes
Pia Wurtzbach 10,000 No Yes
Megan Young 20,000 Yes No
Miriam Quiambao 12,000 No No

Applying the Accrual Basis, we determine the following:

a. Earned Revenue
b. Unearned Revenue
The transaction with Kylie Versoza and Megan Young are recorded as Earned Revenues as the products have
been delivered, thus they are already earned. The transaction with Megan Young results to recording of
Accounts Receivable.

Unearned Revenues, on the other hand, is illustrated by the transaction with Pia Wurtzbach. The payment
received from her shall be recorded as Unearned Income as the products have not been delivered yet. The
transaction with Miriam Quiambao will not be recorded since basically no transaction took place.

Quiz: Fill in the blanks with the correct answer

1. This principle requires that assets should be recorded at original or acquisition cost. __________________
2. This principle requires accounting records should be based on reliable and verifiable data as evidence of transactions.
______________________
3. This principle dictates practicability to rule over theory in determining the valuation of an item. ______________
4. This states that revenue should be recognized when earned and corresponding expenses should be recognized when
incurred during the same period as revenue is earned. ___________________________
5. This principle requires accounting methods and procedures should be applied on a uniform basis from period to period to
achieve comparability in the financial statements. _______________________
6. This principle requires that financial statements should be free from any material misstatement; that if there is any, proper
disclosure should be made. __________________________________
7. This assumption considers the business as an entity distinct and separate from its owners. ________________
8. This assumes that the business will continue to operate for an indefinite period of time. __________________
9. This assumption states that the life of the business is divided into equal periods. _______________________
10. This accounting period begins on January 1 and will end on December 31 of the same year. ______________
11. This accounting period begins on the first day of any month, except January, and ends on the last day of the twelfth month.
____________________
12. This are accounting periods that are less than one year. _________________________
Lesson 6: Accounting Concepts and Principles 3