Accounting Principles and Concepts

• Accounting is referred to as “the language of business” because

it communicates the financial condition and performance of a
business to interested users.
• In order to become effective in carrying out the accounting
procedure, as well as in communication, there is a widely accepted
set of rules, concepts and principles that governs the application of
the accounting. These concepts and principles are referred to as the
Generally Accepted Accounting Principles or GAAP.
• In this article, you will learn and familiarize yourself with the
accounting principles and concepts relevant in the performance of
the accounting procedures. It is a necessity to learn and understand it
because you need to apply these concepts and principles during the
accounting process.
 Guidelines on Basic Accounting Principles and Concepts

GAAP, is the framework and guidelines of the accounting

profession. Its purpose is to standardize  the accounting
concepts, principles and procedures.

Here are the basic accounting principles and concepts:

1. Business Entity
• A business is considered a separate entity from the owner(s)
and should be treated separately. Any personal transactions of
its owner should not be recorded in the business accounting
book unless the owner’s personal transaction involves adding
and/or withdrawing resources from the business.
2. Going Concern
• It assumes that an entity will continue to operate indefinitely. In this basis,
generally, assets are recorded based on their original cost and not on
market value. Assets are assumed to be held and used for an indefinite
period of time or during its estimated useful life.  And  that assets are not
intended to be sold immediately or liquidated.
3. Monetary Unit
• The business financial transactions recorded and reported should be in
monetary unit, such as US Dollar, Canadian Dollar, Euro, etc. Thus, any
non-financial or non-monetary information that cannot be measured in a
monetary unit are not recorded in the accounting books, but instead, a
memorandum will be used.
4. Historical Cost
• All business resources acquired should be valued and recorded based on
the actual cash equivalent or original cost of acquisition, not the prevailing
market value or future value. Exception to the rule is when the business is
in the process of closure and liquidation.
5. Matching
• This principle requires that revenue recorded, in a given accounting period, should
have an equivalent expense recorded, in order to show the true profit of the
business.
6. Accounting Period
• This principle entails a business to complete the whole accounting process over a
specific operating time period.
• Accounting period may be monthly, quarterly or annually. For annual accounting
period, it may follow a Calendar or Fiscal Year.
7. Conservatism
• This principle states that given two options in the amount of business transactions,
the amount recorded should be the lower rather than the higher value.
8. Consistency
• This principle ensures similar and consistent accounting procedures is used by the
business, year after year, unless change is necessary.
• Consistency allows reliable comparison of the financial information between two
accounting periods.
9. Materiality
• Business transactions that will affect the decision of a user are considered
important or material, thus, must be reported properly. This principle
states that errors or mistakes in accounting procedures, that which involves
immaterial or small amount, may not need attention or correction.
10. Objectivity
• This principle states that the recorded amount should have some form of
impartial supporting evidence or documentation. It also states that
recording should be performed with independence, that’s free from bias
and prejudice.
11. Accrual Accounting
• This principle requires that revenue should be recorded in the period it is
earned, regardless of the time the cash is received. The same is true for
expense. Expense should be recognized and recorded at the time it is
incurred, regardless of the time that cash is paid. This is to show the true
picture of the business financial performance.
ENRICHMENT ACTIVITY
Accounting principles. Indicate which principles are violated.
1. The owner-manager bought a computer for personal use. The invoice was
given to the accountant who recorded it as an asset of the business.
2. The statement of financial position of a company included an equipment
purchased from Japan for 350,000 yen. It was reported at that amount in the
statement of financial position while all the other assets were reported in
Philippine pesos.
3. No financial statements were prepared by Michael Go for his business. He
explained that he will prepare the statements when he closes the business,
which he predicts to take place after 20 years.
4. Aside from owning a shoe store, Albert operates a canteen. The assets of
the canteen are reported in the statement of financial position of the shoe
store.
5. Purchased a hammer at a cost of PHP500. This was recorded as an asset and
expense to decrease its value by PHP50 per year for 10 years.
6. A food company ordered a machine needed in the assembly line of its
production department. Upon order, the machine was immediately listed as
one of its assets.
 Types of Business According to Activities
3 types of business organizations:
• Service Business
This type of business offers professional skills, advice and consultations.
Examples: barber shops and beauty parlors, repair shops, banks, accounting and law firms
• Merchandising Business
This type of business buys at wholesale and later sells the products at retail. They make a
profit by selling the merchandise or products at prices that are higher than their purchase
costs. This type of business is also known as "buy and sell".
Examples are: book stores, sari-sari stores, hardware stores
• Manufacturing Business
This type of business buys raw materials and uses them in making a new product, therefore
combining raw materials, labour and expenses into a product for sale later on.
Examples are: shoe manufacturing businesses, car manufacturing plants
Additional information:
• There are businesses that may be classified under more than one type of business. A
bakery, for example, combines raw materials in making loaves of bread (manufacturing),
sells hot pan de sal (merchandising), and caters customers’ orders in small coffee table
servings of ensaymada and hot coffee (service).
Assets invested by the owner
July 1 - Paolo Reyes started a delivery service on July 1, 2013. The
following transactions occurred during the month of July. He invested
PHP800,000 cash and Cars amounting to PHP200,000

Borrowings from the bank

July 2 – Reyes borrowed PHP100,000 cash from PNB for use in his
business.

Asset purchased for cash

July 7 – Bought tables and chairs from Orocan and paid PHP45,000 cash