Accounting Concepts and Principles

Foundations of Accounting and GAAP

Accounting serves as the language of business, communicating financial conditions and performance to users for decision-making. The Generally Accepted Accounting Principles (GAAP) is a set of rules and concepts developed by professionals to guide the recording and reporting of financial information. These principles ensure consistency and effectiveness in financial communication.

Business Entity and Going Concern Principles

The Business Entity Principle (or separate entity concept) requires that business transactions be recorded separately from the personal transactions of the owners. For example, if Sarah owns a bakery and buys a $P25,000$ SUV for personal use, or if John uses a hardware shop's debit card for $P150$ in groceries, these must be kept distinct. The Going Concern Principle assumes a business will continue indefinitely. This allows for practices such as depreciation, where the cost of an asset like a $P50,000$ truck is spread over its useful life (e.g., $P10,000$ per year) rather than being expensed entirely at purchase.

Asset Valuation and Depreciation

Depreciation is recorded via an adjusting entry: debiting Depreciation Expense and crediting Accumulated Depreciation. The Straight-Line Method calculation is:

$\frac{P10,000}{5\text{ years}} = P2,000\text{ per year}$

Book Value is determined by the formula:

$\text{Historical Cost} - \text{Accumulated Depreciation} = \text{Book Value}$

Salvage value represents the estimated worth of an asset at the end of its useful life. Fixed assets like buildings, machinery, and vehicles are reported on the balance sheet under Property, Plant, and Equipment.

Time Period and Monetary Unit Principles

The Time Period Principle divides the business life into equal accounting periods, such as monthly, quarterly (Q1, Q2, Q3, Q4), or annually. The Monetary Unit Principle dictates that only transactions measurable in money are recorded. It assumes a stable currency and requires all reporting in a single unit. For instance, Jollibee must report in pesos even for United States locations. This principle excludes non-quantifiable items like employee morale.

Objectivity and Cost Principles

The Objectivity Principle requires all financial information to be supported by unbiased, verifiable evidence like receipts or invoices. The Cost Principle mandates that assets be recorded at their original purchase price (historical cost). Even if a van bought for $P30,000$ increases in market value to $P35,000$, it remains recorded at $P30,000$. This ensures reliability but may result in the undervaluation of long-term assets due to inflation.

Accrual, Matching, and Disclosure Principles

Accrual Accounting recognizes revenue when earned and expenses when incurred, regardless of cash flow. The Matching Principle pairs expenses with the revenues they helped generate. For example, a $P10,000$ commission for a sale made in November is recorded in November, even if paid in December. Use the following entry to clear the liability:

$\text{Debit: Accrued Expense Payable } P100,000$

$\text{Credit: Cash } P100,000$

The Disclosure Principle requires reporting all material facts, including pending litigation (e.g., a $P1,000,000$ contingent liability), accounting policy changes, and subsequent events.

Conservatism and Materiality Principles

The Conservatism Principle directs accountants to recognize expenses and liabilities immediately while waiting for revenue to be assured. This prevents the overstatement of assets. It involves valuing inventory at the "lower of cost or market" and recording Bad Debt Expense via the Allowance Method. The Materiality Principle allows for the immediate expensing of insignificant items, such as a $P5$ pencil sharpener or an eraser, instead of capitalizing them as assets, as these small amounts do not influence user decisions.