Fundamentals of ABM 1 – Accounting Concepts & Principles

INTRODUCTION

  • Basic purpose of accounting

    • To supply financial information that helps users make informed judgments and better decisions.

    • Information is conveyed primarily through financial statements.

  • Preparation & presentation of financial statements are ruled by Generally Accepted Accounting Principles (GAAP).

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

  • GAAP is the umbrella term for all accounting principles, processes, standards, and underlying assumptions.

  • Provides the uniform rules that ensure comparability, reliability, and relevance of financial statements.

ACCOUNTING CONCEPTS & PRINCIPLES — GENERAL OVERVIEW

  • Also called assumptions or postulates.

  • Serve as the logical ideas & procedures guiding accountants when recording & communicating economic information.

  • Functions

    • Provide a frame of reference for evaluating practice.

    • Guide the development of new practices & procedures.

ACCOUNTING STANDARD-SETTING IN THE PHILIPPINES

  • 1981 – Accounting Standards Council (ASC) established.

  • Republic Act 9298 replaced ASC with the Financial Reporting Standards Council (FRSC).

    • FRSC = current standard-setting body.

  • Outputs

    • Philippine Financial Reporting Standards (PFRS).

    • Philippine Accounting Standards (PAS).

PRIMARY CONCEPTS (INPUTS) — SUBJECT, BASIS, TIMING & ENVIRONMENT

Separate Entity Theory

  • A business has an economic identity separate and distinct from its owners.

  • Only transactions attributable to the entity are recorded.

  • Example: Personal house-repair expense of the owner is not booked by the business.

Objectivity

  • Addresses: “What makes statements verifiable?”

  • Transactions recorded only if backed by objective, authentic evidence (contracts, invoices, O.R.s, prenumbered sales invoices, issued checks).

  • Ensures reliability & auditability.

    • Example: Mr. John’s Bakeshop keeps prenumbered invoices & check vouchers.

Going Concern Assumption

  • Addresses: “Up to when will the entity operate?”

  • Presumes the entity will continue indefinitely unless there is evidence to the contrary.

  • Affects asset valuation, depreciation, and liability classification.

Periodicity (Time-Period Assumption)

  • Addresses: “When should information be reported?”

  • Divides a continuous life into regular intervals (month, quarter, year) for reporting.

  • Enhances comparability & timeliness.

    • Example anecdote: Immigrant grocer “subtract the pants” vs. modern periodic measurement.

    • Depreciation of long-term assets allocated over useful periods.

Monetary Unit

  • Addresses: “In what currency/environment should amounts be stated?”

  • All items measured in a single functional currency.

  • Underlies the rule that only items with measurable monetary amounts are recorded.

Prudence (Conservatism)

  • Exercise caution under uncertainty.

  • When faced with alternative outcomes, choose the one that avoids overstatement of assets/income or understatement of liabilities/expenses.

PROCESS CONCEPTS — CONTENTS & MEASUREMENT OF INFORMATION

Recognition Principle

  • Addresses: “What items belong in the financial statements?”

  • Include an item only if it meets the definition of an element (asset, liability, equity, income, expense).

Measurement Principle

  • Addresses: “How much should be reported?”

  • Requires quantification in monetary terms; usually at original (historical) cost.

  • Two broad measurement bases after initial recognition:

    • Historical Cost – values based on original transaction price.

    • Current Value – updated to reflect conditions on the measurement date (e.g., fair value).

Accrual Accounting

  • Addresses: “When do we record?”

  • Record effects in the period they occur, regardless of cash timing.

    • Revenue is recognized when earned (Revenue Recognition Principle).

    • Expenses recognized when incurred (Expense Recognition Principle).

    • Includes systematic & rational allocation (e.g., depreciation).

    • Example: Joey’s salary for selling 55 cars in December is an expense of December even if paid in January.

Materiality

  • Addresses: “Which items matter?”

  • Information is material if its omission/misstatement could reasonably influence decisions.

  • Depends on size and nature in context of the specific entity.

OUTPUT CONCEPT — COMMUNICATION OF INFORMATION

Presentation & Disclosure Principles

  • Addresses: “How are items shown?”

  • Effective communication requires proper presentation (in statements) and disclosure (in notes) of assets, liabilities, equity, income & expenses.

  • Enhances relevance & faithful representation for users.

QUALITATIVE CHARACTERISTICS OF USEFUL INFORMATION

  • Traits that make information useful to investors, lenders, and other creditors.

Fundamental Qualitative Characteristics

Relevance

  • Information influences decisions by having predictive value, confirmatory value, or both.

    • Predictive Example: Prior statements help management forecast 2012 budget.

    • Confirmatory Example: 2012 results for Product C confirm if launch decision was sound.

  • Includes the threshold of Materiality.

Faithful Representation

  • Depicts phenomena truthfully.

    • Completeness – all necessary descriptions & numbers.

    • Neutrality – free from bias; not slanted to achieve a desired outcome.

    • Freedom from Error – no material errors/omissions in description or process.

Enhancing Qualitative Characteristics

  • Improve usefulness when fundamental qualities are present.

  • Comparability – Enables users to identify similarities & differences across entities or periods.

  • Verifiability – Independent observers can reach similar conclusions.

  • Timeliness – Information is available in time to influence decisions.

  • Understandability – Clear classification, summarization, concise presentation for knowledgeable users.

EXERCISE — IDENTIFYING CONCEPTS (PAGES 44 – 49)

  • 1 – Going Concern.

  • 2 – Separate Entity Theory.

  • 3 – Monetary Unit.

  • 4 – Accrual Accounting (Revenue & Expense Recognition Principles).

  • 5 – Periodicity.

  • 6 – Relevance (Predictive/Confirmatory ➔ material to decision making).

  • 7 – Faithful Representation.

  • 8 – Comparability.

  • 9 – Monetary Unit concept supports stable economic environment.

  • 10 – Periodicity (underlying basis for regular statements).

  • Case-Based Items

    • Joe’s house repair excluded ➔ Separate Entity.

    • Joey’s December salary recorded in December ➔ Accrual / Expense Recognition.

    • Company issues annual reports ➔ Periodicity.

    • Record only monetary events ➔ Monetary Unit.

    • Credit sales recorded as revenue at sale ➔ Accrual / Revenue Recognition.