MODULE WEEK NO.

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North Central Mindanao College
Maranding, Lala, Lanao Del Norte
Tel. No. (063) – 388 – 7213

College of Business Administration and Accountancy

BM 3: Fundamentals of Accounting, Business and Management
First Semester of A.Y. 2021-2022

Topics

CHAPTER 2: ACCOUNTING CONCEPT AND PRINCIPLES

2.1 Nature and Concept
2.2 Framework for the Preparation and Presentation of Financial Statements
2.3 Classification of Accounting Principles
2.4 Accounting Assumptions
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2.5 Accrual Basis of Accounting

2.6 Qualitative Characteristics of Financial Statements

Intended Learning Outcomes

At the end of this chapter, the learners should be able to

 Describe the term “general accepted accounting principle”;
 Discuss the framework for the preparation of financial statements;
 Identify the accounting assumptions;
 Discuss the qualitative characteristics of financial statements; and
 Discuss the different accounting constraints.

Activity

Think and Share:

Discussion

NATURE AND CONCEPT

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 principles (GAAP).

It is termed “generally accepted” because this set of principle has been adopted by all
business entities and mandated by various authorities and accounting organizations
worldwide. GAAP is applicable to all types of business entities regardless of its nature,

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formation, and level of capitalization.

For example, commercial and international banks with billion-peso capital bases like Metro Bank and
Trust Company and Bank of the Philippines Islands are mandated to observe and apply accounting
principles in recording business transactions. In the same manner, merchandising businesses like San
Miguel Corporation and Procter and Gamble should adopt the same set of accounting principles in
recording business transactions.

All financial institutions, manufacturing companies, merchandising businesses, shipping companies,

and airlines, regardless of their amount of capital and management style, or whether they operate
domestically or have international coverage, apply the very same set of principles albeit with little
modification.

In other words, the set of accounting principles used in recording business transactions and events in
preparing financial statements is called generally accepted accounting principles because it is
universally adopted and mandated.

In chapter 1, it has been discussed the accounting concepts and principles in the Philippines
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relative to the preparation of financial statements are stated in the framework and in the
different Philippine Financial Reporting Standards (PFRSs) as issued by the Financial Reporting
Standard Council (FRSC).

FRAMEWORK FOR THE PEPARATION AND PRESENTATION OF FINANCIALL STATEMENTS

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

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

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

Purpose
The purposes of the Framework re to:

1. Assist the FRSC in the development of future 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 to 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.

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Scope of the Framework

The Framework deals with the following:

a. the objectives of the financial statements;

b. the qualitative characteristics that determine the usefulness of information in the financial
statements;
c. the definition, recognition, and measurements of the elements for the financial statements
are constructed; and
d. concept of capital and capital maintenance.

Qualitative Characteristics

Objectives Recognition
Scope of the
Framework
Measurement Disclosure
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Concept of Capital

FIGURE 2.1. SCOPE OF THE FRAMEWORK

CLASSIFICATION OF ACCOUNTING PRINCIPLES

Although the accounting principles are not expressly classified in the Framework and in the various
PFRS, the following classification 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 Assumptions Qualitative Characteristics

Classification
of Accounting
Principles

Accounting Constraints Other Accounting Principles

FIGURE 2.2. CLASSIFICATIONS OF ACCOUNTING PRINCIPLES

ACCOUNTING ASSUMPTIONS

Accounting assumptions are considered the foundation of generally accepted accounting principles.
They serve as the bedrock of all the accounting principles. The applicability of another accounting

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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.

Impliedly indicated in this accounting assumptions in the Framework are three basic accounting
assumptions:

1. accounting entity assumption

2. time period assumption
3. monetary unit assumption

ACCOUNTING
PRINCIPLES

Going concern Assumption

Entity Assumption
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Time Period Assumption

Monetary Unit Assumption

FIGURE 2.3. ACCOUNTING ASSUMPTIONS AS FOUNDATION OF ACCOUNTING PRINCIPLES

Going Concern Assumption

To 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.

Business Is Assumed To Have An Indefinite Life. In recording business transactions and in

preparing financial statements, it is assumed that the definite end of the life of the business
cannot be determined.

In other words, nobody can tell exactly when the business will stop its operating activities. For
example, no one can say when San Miguel Corporation or Metro Bank and Trust Company
will stop their business operations. Neither they can be anybody say that these two business
will stay or remain in operation for the next 100 years.

This feature of the going concern assumption is the underlying reason in recording assets
based on their original cost, and not at their realizable value or selling price. Original cost
refers to the cost involved in acquisition of the assets. Realizable value refers to the amount
that can be collected in the event of the asset is sold.

Business Is Assumed Not to Liquidate. The term “liquidation” implies that the business is
dissolved. Dissolution refers to the formal closure of a business operation. In the liquidation
process, the assets of the business are sold based usually on their realizable value, the

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financial obligations are finally settled, and the remaining cash are distributed to the owners
of the business.

For example, ABC Company is at the brink of bankruptcy, and there are clear indications
that it will cease to operate. In this case, the going concern assumption is no longer
applicable and all other accounting principles will be anchored on this assumption.
Therefore the cost principle will no longer be applicable in the preparation of the financial
statements as well. Thus, if the business owns a building with an acquisition cost of
PHP5,000,000, but it ca be sold only for PHP2,800,000, the value to be used in the preparation
of the financial statement shall be the realizable value of PHP2,800,000. In the notes to the
financial statements, this and other material information should be clearly explained so that
users are properly informed.

Entity Assumption

The term entity in the field of accounting simply means a person. Entity assumption dictates
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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.
Time-Period Assumption

Before discussing the concept of the time-period assumption, it is important to understand first
some basic concepts in order to fully comprehend its essence and nature.

Under the going concern assumption. The only way to know whether a business assumed to
have an indefinite life unless otherwise there is specific evidence to the contrary. Nobody can
definitely predict when the life of a business ends.

For example, the beginning capital of ABC Merchandising is PHP500,000. At the end of its life,
that is 80 years after it was organized and become operational, the ending capital is
PHP8,000,000. Clearly, during its 80 years of operation, the business realized a profit of
PHP7,500,000.

One has to patiently wait therefore when the life of the business ends before he can measure
the true operating performance of the business. Following this same line of thought, the
submission of reportorial requirements shall be made then at the end of the life of the business
in which case it becomes unreasonable already. But the big question to settle is – when will
that be? The answer is – nobody knows.

This particular phenomenon, the indefinite life of the business, results in the necessity to divide
temporarily the life of the business into equal periods to facilitate the determination of
business performance. This specific figure 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:

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1. Monthly – Financial statements are prepared at the end of every month.

2. Quarterly – Financial statements are prepared at the end of every three months.
3. Semi-annually- Financial statements are prepared at the end of every six months.
4. Annually – Financial statements are prepared at the end of every twelve months.

The length of accounting period chosen depends on the needs and information
requirements of the owner and other interested users. Most often, the business adopts the
accounting period of one year. The financial statements prepared in less than one year are
known as “interim financial statements”. Hence, quarterly or semi-annually financial
statements are called interim financial statements.

The annual accounting period for periodic reporting may be on calendar year or on fiscal
year.

Calendar Year. The accounting periods begins on January 1 and ends on December 31 of
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the same year. This is the most common annual accounting period adopted by business
entities because of the convenience is offers relative to taxation requirements.

Fiscal Year. The accounting periods begins of the first day of any month of the year except
January 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, 2014 will end on March 3, 2015.
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 financial statements?

1. Quantifiability aspect, and

2. Stability aspect of peso.

Quantifiability Aspect

The quantifiability aspect suggests that the business transactions and accounting elements
shall be expressed in the financial statements using one common denominator, and that is,
the Philippine peso.

Thus, land in the financial statements should be expressed in peso and not in number of
hectares, or land building should expressed in peso and not in a number of floors or floor
area. Similarly, cash in foreign denominated currency should be converted to peso using the
exchange rate on the date of the financial statements.

Stability Aspect

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 rate 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.

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The dollar standard is used as the benchmarking in determining the present purchasing
power of peso. For example, if the exchange rate is that US $1 is equivalent to ₱50, then the
purchasing power of peso is ₱0.05 or 5 cents. This means that a one peso coin has only 5
centavos real value in the world market using US dollar as the standard exchange
benchmark.

Every day, the value of peso in relation to the US dollar fluctuates. However, under the
stability aspects of peso, the fluctuation is not given accounting recognition in recording
business transactions. The monetary unit assumption is also known as Stable Monetary Unit or
Monetary Convention.

ACCRUAL BASIS OF ACCOUTING

There are two ways of recoding the financial performance of a business entity. They are the
following:
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1. cash basis, and

2. 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 the cash.
In other words, under the accrual basis of accounting, business transactions and events are
recognized when they occur, and not as when the cash or its equivalent is received or paid.
The business transactions are recorded in the accounting records and reported in the
financial statements in the periods to which they relate.

In contrast, the cash basis accounting is a recording procedure that highly emphasizes the
date of cash receipts or cash payment. In other word, transactions are recorded based on
the date of payment or the date of collection. The date of cash inflow or outflow in the
dominating factor in recognizing the transactions.

Sound accounting practice, however, requires the use of accrual basis in recording business
transactions and events.

Illustration 2.1
On June 18, 2015, Carl rendered various electrical services on account to repair the motor
vehicle of Orlando. The services rendered amount to ₱12,000.

The term „on account‟ means that there is no cash payment made or no cash in involved in
the transaction. In other words, Orlando has not yet paid the services rendered by Carl.

Query: In the situation, did Carl realized an income on June 18, 2015? Similarly, did Orlando
incur repair expense on the same date?

Answer: In both queries, the answer is yes. Under the accrual basis, the service provider, Carl,
has realized an income already although cash has not been received yet. On the part of the
customer, Orlando, he has incurred already an expense, though he has not yet paid the
service provider.

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Furthermore, the transactions implies that the service provider has a receivable from his
customer. In other words, after the service has been rendered, Carl has all the right to collect
from Orlando.

On other hand, Orlando, has a payable to the service provider. Upon receipt of the services
extended by the service provider, Orlando has the obligation to pay for the service rendered.

This type of information is recorded and reflected in the financial statements of both entities
under the accrual basis. In the books of account of Carl, he has to include the receivable
from Orlando. Similarly, in the books of customer, Orlando, he has to include liability to the
service provider.

Illustration 2.2

To illustrate further the concept of accrual basis, assume the following: On June 1, 2015, Jona
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rented the vacant commercial space owned by Jolina with a monthly rental of ₱15,000. On
June 30, 2015, Jona has not yet paid Jolina the equivalent of one month rental.

Query: On June 30, 2015, did Jona incur a rental expense amounting to ₱15,000? Similarly, on
June 30, 2015, did Jolina realize a rental income from the lease made by Jona?

Answer: The answer to both queries are all positive. Under the concept of accrual basis, by
June 30, 2015, Jona already incurred an expense in the form of rent although the amount
was not yet paid. On the part of Jolina, she already earned an income in the form of rent, but
the amount was not yet collected.

The point of collection and the point of payment are not necessary in recognizing income
and expense under the accrual basis. The most important concept for an accrual
assumption is that-there exist already the incurrence of expense and the recognition of
income.

Resources and Additional Resources

 Fundamentals of Accountancy, Business and Management 1 (Nick L. Aduana).

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