CHAPTER 2: ACCOUNTING revenue is recognized.

CONCEPTS AND PRINCIPLES 5. Accrual basis of Accounting- PAS 1 requires

that an entity prepares its financial
statements, except for cash flow information,
DEFINITION OF ACCOUNTING CONCEPTS AND
using the accrual basis of accounting.
PRINCIPLES
Set of logical ideas and procedures that guide the Under the accrual basis of accounting,
accountant in recording and communicating economic events are recorded in the period
economic information. They provide a general in which they occur rather than at the point
framework by which accounting practice can be in time when they affect cash.
evaluated and they serve as guide in development of
new practices and procedures. Thus, income is recognized in the period
when it is earned rather than when it is
BASIC ACCOUNTING CONCEPTS collected, while expense is recognized in the
period when it is incurred rather than when
1. Separate Entity Concept- the business is it is paid.
viewed as a separate person, distinct from its
owners. Only the transactions of the business 6. Time Period- It requires that the indefinite
are recorded in the books of accounts. The life of an entity is subdivided into time
personal transactions of the business periods or accounting periods which are
owner(s) are not recorded. The application usually of equal length for the purpose of
of the separate entity concept is necessary so preparing financial reports on financial
that the financial position and financial position, financial performance and cash
performance of a business can be measured flows.
properly, by applying the separate entity
concept, you can objectively know if the The accounting period may be a calendar year
business is really earning profits, or if it has or a natural business year (fiscal year)
the ability to do so.
A calendar year is a twelve month period that
2. Historical Concept Principle- Under this starts on January 1 and ends on December 31.
concept, assets are initially recorded at their
acquisition cost. A natural year or fiscal year is a twelve
month period that starts on a date other
3. Going Concern- it means that the accounting than January 1 and ends on any month.
entity is viewed as continuing in operation
indefinitely in the absence of evidence to the An accounting period that is shorter than 12
contrary. months is called an “Interim Period” an
interim period can be a month or quarter (3
It is also known as continuity assumption. months) or a semiannual period (6 months).

In other words, financial statements are 7. Stable Monetary Unit- the monetary unit
prepared normally on the assumption that assumption has two aspects, namely
the entity shall continue in operation for the quantifiability and stability of the peso,
foreseeable future.
The Quantifiability aspect means that the
The opposite of going concern is Liquidating assets, liabilities, equity, income and
Concern. If the business intends to end its expenses should be stated in terms of a unit
operations or if it has no other choice but to of measure which is the peso in the
do so. Philippines

4. Matching Concept- under this concept, some

costs are initially recorded as assets and
charged as expenses only when the related
 The stability of the peso assumption means Definition of Qualitative Characteristics
that the purchasing power of the peso is
stable or constant and that its instability is Are the qualities or attributes that make financial
insignificant and therefore may be ignored. accounting information useful to the users

In deciding which information should be included in

8. Materiality and Aggregation- This concept
financial statements, the objective is to ensure that
guides the accountant when applying
the information is useful to the users in making
accounting principles. This is because
economic decisions.
accounting principles are applicable only to
Qualitative Characteristics are classified into:
material items.
a. Fundamental Qualitative Characteristics
An item is considered material if its omission
b. Enhancing Qualitative Characteristics
or misstatement could influence economic
decisions. Materiality is a matter of
A. Fundamental Qualitative Characteristics
professional judgment and is based on the
size and nature of an item being judged. Characteristics that relate to the content or substance
of financial information.
The relevance of information is being affected
by its nature and materiality The fundamental qualitative characteristics are
Relevance and Faithful Representation Information
Materiality of an item depends on relative must be both relevant and faithfully represented if it is
size rather than absolute size, what is to be useful.
material for one entity may be immaterial for a) Relevance
another.
 It means the capacity of information to
Very often, materiality is dependent on good
make a difference in a decision made
judgment, professional expertise and
by users
common sense.
 Relevance is the capacity of the
9. Cost- Benefit (Cost Constraint)- under this information to influence a decision
concept, the costs of processing and  Relevance requires that the financial
communication information should not information should be related or
exceed the benefits to be derived from the pertinent to economic decision
information’s use.  Information does not bear on an
economic decision is useless.
10. Full Disclosure Principle- the concept is
related to both the concepts of materiality
Major Ingredients of Relevance
and cost- benefit. Under the full disclosure
principle, information communicated to users
reflect a series of judgmental trade-offs that The ingredients of relevance are predictive
strive for: value and confirmatory value.
Information has predictive value when it can
a. Sufficient detail to disclose matters that
help users increase the likelihood of correctly
make a difference to users
predicting or forecasting outcome of events.
b. Sufficient condensation to make the Example: information about financial position and
information understandable, keeping in financial performance is frequently used in predicting
mind the costs of preparing and using it. dividend and wage payments and the ability of the
entity to meet maturing commitments.
QUALITATIVE CHARACTERISTICS OF FINANCIAL
STATEMENTS Financial information has confirmatory
value if it provides feedback about previous
evaluations. In other words, financial
 information has confirmatory value when it Financial Reporting Standards.
enables users to confirm or correct earlier B.1 Neutrality
expectations.
It means that the financial statements should
Example: a net income measure has confirmatory value if not be prepared so as to favour one party to
it can help shareholders confirm or revise their the detriment of another party
expectation about an entity’s ability to generate
earnings. To be neutral, the information contained in the
financial statements must be free from bias.
The predictive and confirmatory roles of
information are interrelated. Neutrality is synonymous with the all-
b) Faithful Representation encompassing “Principle of Fairness”. To be
neutral is to be fair.
Under the conceptual framework for financial
reporting, the term faithful representation is The information is directed to the common
used instead of the term reliability. needs of many users and not to the
particular needs of specific users.
Faithful Representation means that the
financial reports represent economic b.2) Free from Error
phenomena or transactions in words and
numbers. The descriptions and figures match It means there are no errors or omissions in
what really existed or happened. the description of the phenomenon and the
process used to produce the reported
Simply stated, faithful representation means information has been selected and applied
that the actual effects of the transactions with no errors in the process.
shall be properly accounted for and reported
in the financial statements. In this context, free from error does not mean
perfectly accurate in all respects.
Ingredients of Faithful Representation
B. Enhancing Qualitative Characteristics
b.1) Completeness
Intended to increase the usefulness of the financial
information that is relevant and faithfully represented.
It requires the relevant information should
be presented in a way that facilitates The enhancing qualitative characteristics relate to the
understanding and avoids erroneous presentation or form of financial statements
implication.
a) Understandability
Completeness is the result of adequate
disclosure standard or the principle of full Requires that financial information must be
disclosure comprehensible or intelligible if it is to be
useful
The standard of adequate disclosure means
that all significant and relevant information The information should be presented in a
leading to the preparation of financial form and expressed in terminology that a
statements shall be clearly reported. user understands

To be complete, the financial statements Classifying, characterizing and presenting

shall be accompanied by Notes to Financial information “clearly and concisely” make it
Statements. understandable.

The purpose of the notes is to provide the Financial reports are prepared for users who
necessary disclosures required by Philippine
 have a reasonable knowledge of business and d) Timeliness
economic activities and who review and
analyse the information diligently. It means having information available to
decision makers in time to influence their
b) Comparability decisions.

It means the ability to bring together for Timeliness requires that financial information
the purpose of noting points of likeness must be available or communicated early
and difference. enough when a decision is to be made.
Relevant information may lose relevance if
It enables users to identify and understand there is undue delay in the reporting.
similarities and dissimilarities among items.

Comparability may be made within an entity or

between and across entities.

Comparability within an entity- it is the

quality of information that allows
comparisons within a single entity through
time or from one accounting period to the
next.

Comparability within an entity is also known

as Horizontal Comparability or
Intracomparability

Comparability across entities it is the quality

of information that allows comparison
between two or more entities engaged in
the same industry.
This comparability is also known as
intercomparability or dimensional
comparability
The financial statements of different entities
are compared in order to evaluate their
relative financial position, financial
performance and cash flows.

c) Verifiability

It means that different knowledgeable and

independent observers could reach
consensus that a particular depiction is a
faithful representation.

The information is verifiable in the sense that

is supported by evidence so that an
accountant that would look into the same
evidence would arrive at the same decision
or conclusion.