NORTHERN LUZON ADVENTIST COLLEGE

DEPARTMENT OF BUSINESS EDUCATION

COURSE: Conceptual Framework and Accounting Standards

LESSON 1: ACCOUNTING CONCEPTS AND PRINCIPLES

I. Introduction

Accounting concepts and principles (assumptions or postulates) are a set

of logical ideas and procedures that guide the accountant in recording and
communicating economic information. They provide a general frame of
reference by which accounting practice can be evaluated and they serve as
guide in the development of new practices and procedures.

II. Learning Outcomes

After reading this chapter, the students should be able to:

 Identify accounting assumptions
 Discuss the qualitative characteristics of financial statements and the
different accounting constraints; and
 Describe other generally accepted accounting principle.

III. Integration of Faith:

No servant can serve two masters, for either he will hate the one and love
the other, or he will be devoted to the one and despise the other. You cannot
serve God and money. Luke 16:13

IV. Topics for Reading:

Book: Financial Accounting and Reporting
Fundamentals of Accounting

Additional Readings:
Introduction to accounting
https://bit.ly/34McCUF
https://bit.ly/31yB2ik
https://bit.ly/3b2pzKS
 TOPIC: ACCOUNTING CONCEPTS AND PRINCIPLES

 Introduction

Accounting concepts and principles (assumptions or postulates) are a set of

logical ideas and procedures that guide the accountant in recording and
communicating economic information. They provide a general frame of reference by
which accounting practice can be evaluated and they serve as guide in the
development of new practices and procedures.

Accounting concepts and principles provide reasonable assurance that

information communicated to users is prepared in a proper way. For example, doctors
have a proper way of performing surgery on a patient; engineers have a proper way of
constructing a bridge; accountants too have a proper way of recording and
communicating economic information. This is to maximize usefulness of accounting
information to the users.

 Basic Accounting Concepts

There are numerous concepts and principles used in accounting. These are
source from the Standard (PFRS), the Conceptual Framework for Financial Reporting, or
Generally Accepted Accounting Principles use by profession due to long-time use.
Accounting is constantly changing and new concepts are continuously emerging.

 Philippine Financial Reporting Standards (PFRSs)

The Philippine Financial Reporting Standards (PFRSs) are Standards and

Interpretations adopted by the Financial Reporting Standards Council (FRSC). They
consist of the following:

a. Philippine Financial Reporting Standards (PFRSs);

b. Philippine Accounting Standards (PSAs); and
c. Interpretations

 Generally Accepted Accounting Principle

The recording of business transactions, the preparation of financial statements, and the
practice of accounting in general are governed by a set of ground rules and
procedures.

This set of rules, procedures, assumptions, postulates, and concepts that are followed in
recording business transactions and events, and in the preparation of general purpose
financial statements is called generally accepted accounting principle (GAAP).
It is termed “generally accepted” because this set of principles has been adopted by
all business entities and mandated by various authorities and accounting organizations
worldwide. GAAP is applicable in all types of business entities regardless of its nature,
formation, and level of capitalization.

 Conceptual Framework for Financial Reporting

The Framework sets out the concepts that underlie the preparation and presentation of
financial statements for external users.

Otherwise stated, the Framework basically outlines the general guidelines, assumptions,
and principles on the preparation of the financial statements, and how the items
appearing on the face of the financial statements should be presented.

The Framework is not a Philippine Financial Reporting Standard (PFRS) and, hence, does
not define standards for any particular measurement or disclosure issue. The Framework
serves as the general guidelines regarding the preparation of the financial statements.

The key point to remember is that – the Framework serves as the general guidelines in
preparing financial statements, while a particular standard governing a certain
financial item provides specific guidelines on measurement and disclosure.

In the event there are conflicts between the Framework and the PFRS, the conditions
and requirement and disclosure set by the Philippine Financial Reporting Standards will
prevail over those of the Framework.

The purposes of the Framework are to:

1. Assist the Financial Reporting Standard Council (FRSC) in the development of

PFRS and in its review of existing Philippine Accounting Standards.

2. Assist preparers of financial statements in applying PFRS and in dealing with

topics not yet covered by any PFRS.

3. Assist auditors in forming an opinion as to whether financial statements conform

with the PFRS.

4. Assist users of financial statements in interpreting the information contained in

financial statements.

5. Provide those who are interested in the work of FRSC with information about its
approach to the formulation of PFRS.
 Classification Of Accounting Principles

Although the accounting principles are not expressly classified in the Framework and in
the various PFRS, the following classifications are made to simplify the discussion of the
different accounting principles:

1. Accounting Assumptions
2. Qualitative Characteristics
3. Accounting Constraints
4. Other Accounting Principles
ACCOUNTING ASSUMPTION

Accounting assumptions are considered the foundations of generally accepted

accounting principles. They serve as the bedrock of all other accounting principles. The
applicability of other accounting principles must consider and be anchored in
accordance with accounting assumptions.

Without these accounting assumptions, there could be no uniformity in the

practice of accounting which may result in having a distorted and meaningless
financial statements.

The four basic accounting assumptions are:

1. Going Concern Assumption

2. Entity Assumption
3. Time Period Assumption
4. Monetary Unit Assumption

1. Going Concern Assumption

The going concern assumption, otherwise known as continuity principle,
assumes that the business is going to operate or will continue to exist for an
indefinite period of time. The entity is assumed not to liquidate or curtail
materially the scale of its operations.

There are two salient features of going concern assumption, namely,

a. The business is assumed to have an indefinite life; and
b. The business is not going to liquidate.

2. Entity Assumption
The term entity in the field of accounting simply means a person.
Entity assumption dictates that the business is treated as a person with a
personality that is separate and distinct from the owner or owners.
Unlike human person, a business is a juridical person. It is created by the
operation of law. As a juridical person, it has a name duly approved by the
concerned government agency. It may acquire property in its own name, enter
into a contract, or sue or be sued.
Accounting is concerned only with the transactions of the business.

3. Time-Period Assumption
The total life of the business will be divided into several periods so that its
operating performance for that particular period can be measured reliably. This
specific period in the sphere of accounting principles is known as the accounting
period or time-period.
 The different accounting periods or time-periods used to measure the
operating performance and financial position of a business are monthly,
quarterly (3 months), semi-annually (6 months), and annually (12 months).
The annual accounting period for periodic reporting may be on calendar
year or on fiscal year.

Calendar Year. The accounting period begins on January 1 and ends on

December 31 of the same year. This is the most common annual accounting
period adopted by business entities because of the convenience it offers relative
to taxation requirements.

Fiscal Year. The accounting period begins on any day of a certain month
except January 1 and ends on the last day of the twelfth month completing a
one-year period. For example, a fiscal period that begins on April 1, 2020 will end
on March 31, 2021.

4. Unit of Measure Assumption

The unit of measure assumption or monetary unit assumption answers the
basic question – What is the value of item appearing in the face of the financial
statements?
The monetary unit assumption has two aspects, namely,
a. Quantifiability aspect
The quantifiability aspect suggests that business transactions and
accounting elements shall be expressed in the financial statements using one
common denominator, and that is, the Philippine peso.

b. Stability aspect of peso

The stability aspect assumes that the Philippine peso has a stable
monetary value. This means that the purchasing power of the peso is
constant regardless of inflation rates or fluctuation in money values. In this
regard, the function of accounting is to account for peso only and not for
changes in its purchasing power.

QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS

The qualitative characteristics refer to the different attributes that make the
information provided in the financial statements useful to users. Financial statements
prepared without the different qualitative characteristics are not meaningful to the
users.

The qualitative characteristics are broadly classified into

1. fundamental qualitative characteristics, and

2. enhancing qualitative characteristics.
1. FUNDAMENTAL QUALITATIVE CHARACTERISTICS
The fundamental qualitative characteristics include the following:

a. Relevance
Information is relevant if it can affect the decision of users. Without this
trait, information is deemed irrelevant. Relevant information has the following
aspects:
i. Predictive value – Information has a predictive value if it can help users
to make predictions about future outcomes.

ii. Confirmatory value (or Feedback value) – This concept is related to

the predictive value. Information has a confirmatory value if it can
help users confirm their past predictions.

iii. Materiality – is an „entity-specific‟ aspect of relevance, meaning it

depends on the facts and circumstances surrounding a specific entity.
For example, an item may be considered by one business as material
but is considered by another as immaterial. Information is material if
omitting it or misstating it could influence the decision or users.

b. Faithful Representation
Information is faithfully represented if it is factual, meaning it represents the
actual effects of events that have taken place. For example, if a business
makes total sales of P100,000, it should report the amount in its financial
statements – no more, no less!
Faithfully represented information has the following aspects:
i. Completeness – All information necessary for users to have a complete
understanding of the financial statements is provided.

ii. Neutrality – Information is selected or presented without bias.

Information is not manipulated to increase its favorability or decrease
its unfavorability.

iii. Free from Error – Free from error means the information is not materially
misstated. This does not mean, however, that accounting information
must be perfectly accurate in all respects because some accounting
information necessarily needs to be estimated. Free from error means
there are no errors in the description and in the process by which the
information is selected and applied.
 2. ENHANCING QUALITATIVE CHARACTERISTICS
The enhancing qualitative characteristics include the following:
a. Verifiability
Information is verifiable if different users could reach a general agreement
as to what information intends to represent. For example, if the accountant
presents ending cash balance at P10,000. Auditor should also come up with
the same ending balance upon audit. Hence, if they are the same, the
balance is verified.
Verifiability also implies that transactions are supported with business
documents.

b. Comparability
Financial statements have the characteristic of comparability if it enables
users to evaluate accounting information by comparison with similar data
from other companies and industry averages.

c. Understandability
Information is understandable if it is presented in a clear and concise
manner. On the other hand, users are expected to have a reasonable
knowledge of business activities and a willingness to analyse the information
diligently.

d. Timeliness
If there is undue delay in the reporting of information, it may lose its
relevance. Financial information and other relevant data that are needed by
the decision maker now should be made available now. If the needed
information is delayed, then such information may no longer serve the
purpose when available. Financial information, therefore, should be timely.

ACCOUNTING CONSTRAINTS

Accounting constraints refer to elements that affect the qualitative

characteristics of relevance and reliability.

In other words, these are factors that act as impediments to attain relevance
and reliability in the preparation of financial statements:

The constraints enumerated in the Framework are

1. Balance between Benefit and Cost (Cost-Benefit)

The mode of gathering, processing, and presenting information involves
the incurrence of cost and expenses. However, the benefit derived from the
information should exceed cost of providing it. If the cost of gathering economic
information exceeds the benefit that may derived, such information is excluded.
 2. Balance between Qualitative Characteristics
In practice, a balancing or trade-off between qualitative characteristics is
often necessary. This means that one qualitative characteristic is given
preferential importance in the preparation of the financial statements. The
selection of one qualitative characteristic will lead to the rejection of the other.
For example, in most instances, the trade-off is between relevance and
reliability. Relevant financial statements are prepared on time, that is, available
when needed for decision making. However, reliable financial statements may
take ample time in gathering economic data, the processing procedures, and
the presentation. The possibility is that the financial statement is complete, but it
may no longer serve the purpose.

3. True Presentation vs Fair Presentation

True financial statement presentation implies that all the economic
transactions of business are included regardless of the amount. Fair presentation,
on the other hand, may suggest that some data may be omitted, but its omission
will not affect the decision of the users.
For example, a multi-billion company omitted the receivable from one of
its customers amounting to P5,000 in its financial statement. The financial
statement in this case is not a true financial statement because it does not
include all transactions and events. However, the financial statement is fairly
presented because the omission of the P5,000 receivable will not change or
influence the decision of the users.

OTHER GENERALLY ACCEPTED ACCOUNTING PRINCIPLE

Aside from the principles that have been expressly mentioned in the Framework,
there are still other principles that are discussed in different Philippine Financial
Reporting Standard.

The following principles are still observed in the preparation of financial statements:

1. Substance over form

Substance over form is an accounting concept which means that the
economic substance of transactions and events must be recorded in the
financial statements rather than just their legal form in order to present a true
and fair view of the affairs of the entity.

2. Conservatism or Prudence
The convention of conservatism, also known as the doctrine of prudence,
is a policy of anticipating possible future losses but not future gains. This policy
tends to understate rather than overstate net assets and net income, and
therefore lead companies to "play safe".
3. Objectivity Principle
The objectivity principle is the concept that the financial statements of an
organization be based on solid evidence. The intent behind this principle is to
keep the management and the accounting department of an entity from
producing financial statements that are slanted by their opinions and biases.

4. Cost Principle
The cost principle dictates that assets on the date of acquisition should be
recognized at cost. The term “costs” includes acquisition price and all incidental
expenses related to the acquisition.

5. Materiality Principle
The basic premise of materiality principle is that financial statements
should include only information that is considered material or significant.
In evaluating the materiality of an item, the following should be considered:
a. The size of the item in relation to other item or to the total resources; and
b. The nature of transaction.

6. Matching Principle
The matching principle requires that expenses incurred be matched
against the revenue realized within the same accounting period.
The recognition of unpaid liabilities and unearned revenues at the end of
the calendar year is made on the basis of the matching principle.

7. Consistency Principle
Accounting methods and procedures should be applied on a uniform
basis from period to period to achieve comparability in the financial statements.
If accounting procedures are not applied uniformly from period to period,
the users will find difficulty in evaluating the operating performance of the
business. Change in accounting method and procedures are discouraged.

8. Adequate Disclosure Principle

The financial statements should present all accounting information that
will influence the economic decision of the different users.
The disclosure requirements simply mean that all information needed in
order that the financial statement will be more understandable to the users or will
facilitate the decision-making process of the users should be made available in
the notes to the financial statements.
9. Accrual Basis of Accounting
There are two ways of recording the financial performance of a business
entity. They are cash basis, and accrual basis.
In cash basis, transactions are recorded only when cash is involved.
However, in accrual basis, transactions are recorded whenever they happen,
notwithstanding the inflow or outflow of cash.
In accrual basis, income is recognized when earned regardless of when
cash is received, and expenses are recorded when incurred regardless of when
the amount is paid.
Sound accounting practice, however, requires the use of accrual basis in
recording business transactions and events.
References:

1. Financial Accounting and Reporting (Millan, 2018)

2. Accounting for Partnership and Corporation (Baysa & Lupisan, 2018)
3. Financial Accounting and Reporting Fundamentals (Cabrera & Cabrera, 2019)
4. Fundamentals of Accounting 1 and 2 (Aduana, 2016)