Unit 4: Accounting Concepts and Principles

Lesson 4.2
Application of Accounting Concepts and Principles
Contents
Introduction 1

Learning Objectives 2

Quick Look 3

Learn the Basics 4

Business Entity Concept 5
Monetary Unit Concept 5
Going Concern Principle 5
Time Period Principle 6
Objectivity Principle 6
Cost Principle 7
Accrual Accounting Principle 7
Revenue Recognition Principle 8
Matching Principle 9
Full Disclosure Principle 9
Conservatism Principle 9
Materiality Principle 10

Case Study 11

Keep in Mind 12

Try This 12

Practice Your Skills 14

Challenge Yourself 15

Photo Credit 16

Bibliography 16
Unit 4: Accounting Concepts and Principles

Lesson 4.2

Application of Accounting
Concepts and Principles

Introduction

For people to follow rules and regulations, they must be thoroughly explained and
consistently implemented. Although the famous adage says, “Ignorance is not an excuse.”,
an individual may still violate these rules and regulations if they are not aware of it.

This principle also holds true in the business world. It can be challenging for businesses to
be familiar and to be updated of the guidelines, rules, and regulations when dealing with
economic transactions. One wrong move may compromise the operations of a business or,
worse, it may affect the company’s image or position in the market.

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Unit 4: Accounting Concepts and Principles

Learning Objectives DepEd Competency

At the end of this lesson, you should be able to Solve exercises on accounting principles as
do the following: applied in various cases
(ABM_FABM11-IIIb-c-16).
● Give examples of transactions
applying accounting concepts and
principles.
● Differentiate accounting concepts and
principles.
● Analyze violations of accounting
concepts and principles in business
transactions.

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Unit 4: Accounting Concepts and Principles

Quick Look

Securities and Exchange Commission

The Securities and Exchange Commission (SEC) is a government agency mandated to

regulate corporations and financial institutions. It is also established to protect the public
from investing in scams and other related fraudulent business activities.

To uphold its mandate, one of SEC’s tasks is to assess all the financial statements submitted
by corporations. The Securities Regulation Code (SRC) ensures that financial reports are
audited by an independent Certified Public Accountant (CPA). Moreover, the SRC’s
Implementing Rules and Regulations (IRR) contain conditions for internal record keeping
and accounting controls for businesses to follow.

Questions to Ponder
1. What is the function of the Securities and Exchange Commission?
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2. What is the role of a Certified Public Accountant in performing the mandate of the
Securities and Exchange Commission?
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3. How can the public benefit from the mandate of the Securities and Exchange
Commission?
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Unit 4: Accounting Concepts and Principles

Learn the Basics

In the previous lesson, the accounting concepts and principles were introduced. These are
sets of rules and guidelines that a business follows when preparing financial reports.
Following these accounting concepts and principles ensure that a company’s reports are
valid, reliable, consistent, and comparable.

Each concept and principle affects how users of accounting information read and analyze
financial data. Thus, it is imperative that businesses adhere to these concepts and principles.
The figure below summarizes the various accounting concepts and principles.

Figure. Businesses must adhere to the basic accounting concepts and principles.

Essential Question

How do accounting concepts and principles affect a business’s economic

activities?

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Unit 4: Accounting Concepts and Principles

Business Entity Concept

The business entity concept states that the business’s financial transactions must be
recorded separately from those of its owners and other businesses. Examine the following
application of the concept.

Mr. Wilkins owns an electronic company and drives a personal luxury car. According to the
business entity concept, Mr. Wilkin’s luxury car should not be counted as part of his
company’s assets.

Ms. Sunshine rented a duplex house for ₱30,000.00 per month (₱15,000.00 for each house).
She uses the left house of the duplex for her business and the right house of the duplex for
personal purposes. According to the business entity concept, only half of the total rent per
month, or ₱15,000, should be the valid expense of Ms. Sunshine’s business.

Monetary Unit Concept

The monetary unit concept states that a business only records transactions expressed in
terms of a currency. Examine the following application of the concept.

Mr. Nagoya, the CEO of Tokyo Builders, invested additional capital in the form of 20 hectares
of land. Under the monetary unit principle, the said investment can not be recorded unless
there is a statement of value in terms of a common monetary unit.

Flash Logistic Company got one of its delivery vans seriously damaged in a road accident
and was overhauled. Flash Logistic Company can only account for the insurance and repair
expenses it has to pay to get the delivery van in working condition.

Going Concern Principle

The going concern principle is the assumption that a business entity would continue its
operations indefinitely. Examine the following application of the principle.

Star Company has five branches in various places in the metro. However, its Cavite branch
will be closed due to financial instability but will continue with four others. In going concern,
Star Company's move in shutting down one of its branches does not harm the capacity of the
company to operate.

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Cloud Residences is in a severe financial crisis and cannot pay its debts. The government
supports Cloud Residences and guarantees all payments to creditors. Despite its poor
financial situation, the company is still a going concern. Therefore, it will continue its
day-to-day operations.

It is important to note that the going concern assumption should be terminated if there is
evidence that the company will continue to suffer losses or when the company will cease its
operations.

Time Period Principle

The time period principle states that businesses should report their financial transactions
over a standard period of time, which could be weekly, monthly, quarterly, semi-annually, or
annually. Examine the following application of the principle.

The Gamma Company provided services valued at ₱10,000.00 to Meta Company during the
year's second quarter. The Meta company will pay for these services next quarter. According
to the time period principle, if Gamma Company prepares its financial statements at the end
of the second quarter, the revenue of ₱10,000 from the services made to Meta Company
will reflect in its income statement for the second quarter.

The COO of Sun Investments will present the business report for the first quarter to the
board of directors. The financial controller of the business is tasked to prepare the financial
report. Though the business is in its third quarter of operations, the financial controller
should make some adjustments on its report and include only the transactions made during
the first quarter. This move is supported by the time period principle.

Preparing financial statements in specified time periods allows users of accounting

information to make sound decisions because the data provided to them are timely and
relevant.

Objectivity Principle
The objectivity principle states that financial reports must be based on solid evidence such
as income statements and business documents. Examine the following application of the
principle.

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Unit 4: Accounting Concepts and Principles

Company NYZ asked an auditing firm to conduct an external audit of the company's financial
records. When the auditor validated the documents, he requested customer receipts. The
objectivity principle is violated if Company NYZ cannot present valid receipts because the
data in the financial statements cannot be verified.

PH Logistics applied for a bank loan, and the bank needed audited asset documentation to
approve the loan. When the loan documentation process began, the business was asked to
present the audited papers of assets to be kept as collateral. If the company fails to do so,
the loan will not be granted since the objectivity principle requires all assets in the
accounting books to be audited and to have proper documentation.

Cost Principle
The cost principle states that acquired assets, liabilities, and equity investments should be
recorded at their original cost. Examine the following application of the principle.

Asia Trading purchased 2,000 units of an item for ₱100.00 per unit. The current price of
inventory is ₱125.00 per unit. The company should report inventory at its total purchase cost
of ₱200,000.00 and not at its total current price of ₱250,000.00. Recording the amount of
inventory at its acquisition cost aligns with the cost principle.

Roma Cleaning Services bought a piece of equipment for ₱60,000.00. It is estimated to be

worth ₱30,000.00 four years from now. Upon purchase, the business should still report the
equipment at its original cost regardless of the expected price adjustment in the future.

Accrual Accounting Principle

The accrual accounting principle states that the revenue and expenses of a business are
recorded when incurred rather than when payment is received or made. Examine the
following application of the principle.

JM Builders received an electricity bill worth ₱75,000 on December 26. The company intends
to pay it on January 15. According to the accrual principle, the electricity bill should be
recorded as an expense in the year-end financial statements of the business even if payment
has not been made yet.

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Unit 4: Accounting Concepts and Principles

Durian Company signed a three-year contract with Rock Security Agency for its security
services and agreed to settle the contract price once it ended. However, the accountant of
Durian Company records the annual cost of the expenses at year-end until the contract
expires. Regardless of whether the payment has been made, Durian Company should
include the cost of the security services in their financial reports as long as the expense was
incurred. This is allowed under the accrual accounting principle.

Revenue Recognition Principle

The revenue recognition principle guides businesses on how and when revenue is to be
recognized. Examine the following application of the principle.

Friday Company received a check amounting to ₱75,000.00 from Lopez Law Firm for
marketing services to be rendered in the next quarter. Friday Company did not record the
amount in the check as revenue, since the service has not yet been given to the client.
According to the revenue recognition principle, Friday Company should only record revenue
in the period when it was realized and earned—not necessarily when cash is received.

Mexico Auditing performed services for Best Retails on credit. Mexico Auditing recorded the
cost of services as revenue, even though it was not yet paid. The revenue recognition
principle states that Mexico Auditing should recognize revenue when a service is performed
for a client, even if it is not yet paid.

Check Your Progress

What is the difference between accrual accounting principle and revenue

recognition principle?
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Unit 4: Accounting Concepts and Principles

Matching Principle
The matching principle states that a business should report revenues together with the
related expenses in the same reporting period. Examine the following application of the
principle.

The sales team of Mozart Services earned a 15% commission for January. It will be credited
to the team member's February payroll. Under the matching principle, Mozart Services
should record revenue as well as an expense for the commission given to the sales team in
January.

Monday Company gives bonuses to its employees every year. However, the bonus is paid in
the following year. The business should record the bonus as an expense when the
employee earned it within the year. The matching principle requires that the Monday
Company record the amount of the bonuses at the same period that it was earned.

Full Disclosure Principle

The full disclosure principle states that financial reports should include all relevant and
necessary information that would affect the users of accounting information’s understanding
of the financial statements. Examine the following application of the principle.

A passing pedestrian had an accident in one of O Company’s properties and was severely
injured. The pedestrian sued the company for money and will likely win the lawsuit. Under
the full disclosure principle, O Company must disclose to their investors that they have a
pending lawsuit, which could potentially affect the company's financial situation.

Conservatism Principle
The conservatism principle states assets and revenue should not be overstated while
liabilities and expenses should not be understated. Examine the following application of the
principle.

Red Residences is in the middle of a lawsuit against Gold Residences for patent infringement
and anticipates getting a large settlement from the latter. But due to uncertainty, Red
Residences doesn't record the gain on its financial reports. Recording gains violates the

4.2. Application of Accounting Concepts and Principles 9

Unit 4: Accounting Concepts and Principles

conservatism principle, which states that assets or revenues should not be overstated while
liabilities or expenses should not be understated.

Materiality Principle
The materiality principle states that companies can ignore some accounting standards if
the impact of an immaterial asset is negligible. Examine the following application of the
principle.

Grace Company bought wastebaskets for the back offices amounting to ₱200.00. Instead of
depreciating it over its useful life of five years, the company recorded ₱200.00 as an
expense. The materiality principle allows Grace Company to recognize the cost of
wastebaskets as an expense during the year it is acquired. Doing so will not mislead users of
accounting information when they read Grace Company’s financial reports.

Closer Look

Philippine Financial Reporting Standards

Businesses in the Philippines follow the Philippine Financial Reporting
Standards (PFRS) when preparing financial reports. Most of the PFRS are
adopted from the International Financial Reporting Standards (IFRS), but
some with modifications and amendments. These standards are based
on the Generally Accepted Accounting Principles (GAAP).

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Unit 4: Accounting Concepts and Principles

Case Study

Suspension of Trading of Shares of PAL Holdings in the PSE

The trading of shares of PAL Holdings in the Philippine Stock Exchange
(PSE) was suspended last June 18, 2021, because its auditor, SyCip
Gorres Velayo & Co. (SGV & Co.), was not able to give an opinion on
PAL’s audited financial statements.

The failure to give an opinion violates Rule 68 of the Securities Regulation

Code (SRC). Rule 68 requires all companies to submit audited financial
statements with an unqualified opinion from their respective auditor.

An unqualified opinion from an auditor means that the financial reports

submitted to them were accurate and fair.

To cite SGV & Co,. the auditing firm was “unable to obtain sufficient
appropriate audit evidence” for an opinion on PAL’s financial statement.

The role of auditors and the Securities and Exchange Commission

(SEC) is important because they ensure that companies present their
financial reports accurately and fairly.

PAL share trading halted on audit disclaimer

Keren Concepcion Valmonte, “PAL share trading halted on
audit disclaimer,” BusinessWorld, June 18, 2021,
https://www.bworldonline.com/pal-share-trading-halted-on-a
udit-disclaimer/, last accessed on March 11, 2022.

4.2. Application of Accounting Concepts and Principles 11

Unit 4: Accounting Concepts and Principles

Keep in Mind

● Accounting is driven by various concepts and principles that businesses must adhere to
when dealing with financial information. These guidelines are essential to guarantee
that statements are comprehensive and constant.

● Accounting concepts and principles guide businesses in analyzing economic events and
when preparing financial reports. They help companies track errors and avoid
fraudulent activities.

Try This

A. True or False. Write true if the statement is correct; otherwise, write false.

________________ 1. Personal transactions made by the owner cannot be recorded

in the business’s accounting books.

________________ 2. Even if a company is in a financial crisis, it can still be

considered a going concern if it can ensure the continuity of its
operations.

________________ 3. When a company buys equipment, the cost should be recorded

at the current market value.

4.2. Application of Accounting Concepts and Principles 12

Unit 4: Accounting Concepts and Principles

________________ 4. A business may remove financial data that may affect the image
of the business among its users.

________________ 5. In case of doubt, expenses and liabilities should not be

understated.

________________ 6. A company that received its electric bill should not record it
until it is paid.

________________ 7. A commission must be recorded along with the revenue on the

accounting year it was incurred.

________________ 8. An entity should record financial activities that can be

recognized in currency terms.

________________ 9. An asset that has a negligible impact on the business’s financial

statements can be reported as an expense.

________________ 10. A business that offers services to a client on credit must wait for
its customer to pay before recognizing it as a revenue.

________________ 11. In the objectivity principle, a business transaction is invalid if it

is not supported by any solid evidence.

________________ 12. A business purchased insurance that is good for one year
should record the expenses right away.

________________ 13. Asset and revenue can be overstated because it reflects a

better financial performance.

________________ 14. When a business paid rent in advance, the cost of rent that
should be recorded as an expense is equivalent to the worth
of a prepaid rent that expired.

________________ 15. A transaction that violates a principle or concept must not be

recognized.

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Unit 4: Accounting Concepts and Principles

Practice Your Skills

Correcting the Mistakes

Correct the sentences to make them adhere to accounting concepts and principles and
make the transactions valid.

1. Luna Company performed consulting services for a client on credit amounting to

₱55,000.00. The company will recognize the revenue upon receipt of payment.
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2. White Logistics suffered from losses due to low demand. Its cash flow is below
target, and all measures have been taken into consideration. There is enough
indication that the company will continue to suffer persistent losses. Under the
going concern assumption, the company must continue its operations indefinitely.
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3. Atty. James Barron lent money to his law firm to finance the expansion of the
business. No transaction was recorded since the money was provided by the owner.
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4. East Company hired an external auditor to audit its books. The auditor found out
that some transactions were not supported by documents but the auditor
continued its external audit and approved the company’s books.

4.2. Application of Accounting Concepts and Principles 14

Unit 4: Accounting Concepts and Principles

__________________________________________________________________________________________
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5. Bright Tutorial Service purchased land worth ₱560,000.00. It is estimated that the
price of the land two years from now will be ₱880,000.00. The business recorded
land as ₱880,000.00 since land is known to appreciate over time.
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Challenge Yourself

Answer the following questions:

1. What do you think are the challenges that businesses face when implementing the
rules and regulations in reporting financial data?
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2. Choose two accounting concepts or principles and explain them from your own
understanding.
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Unit 4: Accounting Concepts and Principles

3. From your chosen accounting concept and principle in no. 2, provide a business
transaction related to them.
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Photo Credit
Saving budget investment, by stevepb is free to use under the Pixabay license via Pixabay.

Bibliography
Accounting Tools, Inc. “Basic Accounting Principles”. Last modified June 15, 2021.
https://www.accountingtools.com/articles/2017/5/15/basic-accounting-principles

“Mandate, Mission, Values and Visions.” Securities and Exchange Commission. Accessed
January 28, 2022.
https://www.sec.gov.ph/about-us/mandate-mission-values-and-vision-2/.

Valmonte, Karen Concepcion. “PAL share trading halted on audit disclaimer.

BusinessWorld, June 18, 2021.
https://www.bworldonline.com/pal-share-trading-halted-on-audit-disclaimer/.

Wood, Frank, and David Horner. Business Accounting Basics. Harlow: Pearson Education
Limited, 2010.

4.2. Application of Accounting Concepts and Principles 16