Basic Accounting Principles



Accounting Principles (Accounting Assumptions) are the various concepts and traditions which have been developed over a period of time and have become well-accepted by the profession. The Basic Accounting Principles accounting provide a foundation for the recording of transactions and the preparation of financial statements.

The Basic Accounting Principles

Going Concern Assumption

This accounting principle states that the entity is assumed to carry on its operations for an indefinite period of time. In other words, the accountant should assume that a business entity would continue in the future indefinitely.

The financial statements are prepared on a going concern basis unless the entity either.

  1. Intends to liquidate the entity or to cease trading, or
  2. has no realistic alternative but to do so.

The measurement basis involving mixture of costs and values is appropriate only when the entity qualifies as a going concern. If the entity is under liquidating concern, the appropriate measurement basis is realizable value, i.e., estimated selling price less estimated costs to sell for assets and the expected settlement amount for liabilities.

(ex. You don't go into a serious relationship thinking that it would end in 6 months. You assume that the relationship you entered into would go the distance. This goes with businesses as well.)

Basic Accounting Principles

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Separate Entity Principle

This accounting principle is also called Accounting entity / Business entity concept/ Entity concept. It states that the entity is treated separately from its owners. This principle defines the area of interest of the accountant. Only those pertaining to the entity are accounted for and included in the financial records. The personal assets, obligations and transactions of owners are excluded.

(ex. You don't go to the Internal Revenue Service and claim your dinner expenses with your family as a deduction for your business expenses. You don't consider your winnings from gambling at a casino as business income either.)

Stable Monetary Unit Principle

This accounting principle states that assets, liabilities, equity, income and expenses are stated in terms of a common unit of measure, which is the peso in the Philippines and dollar in the United States. The purchasing power of money is regarded as stable or constant and that its instability is insignificant and therefore ignored.

(This principle goes against the views of economists. But hey, we don't care. This is done in order to simplify the financial statements.)

Time Period

Sometimes called Periodicity or Accounting Period Concept, it states that the life of the business is divided into series of reporting periods. An accounting period is usually 12 months and may either be a calendar year or fiscal year period. A calendar year period starts from January 1 and ends at December 31 of that same year. A fiscal year period is also a 12-month period but starts at a date other than January 1.

(Our life is divided into years. That's why we celebrate birthdays. The life of an egg is measured in a girl's menstrual cycle. You get my drift.)

Materiality concept

This principle states that information is material if its omission or misstatement could influence economic decisions. Materiality is a matter of professional judgment and is based on the size and nature of an item being judged.

(You can't account for that $.0048 no biggie. The company won't shut down because of that. But if you do eventually find it, well congats!)

Cost-benefit Principle

Sometimes called Reasonable assurance/ Pervasive constraint/ Cost constraint principle, it states that the cost of processing and communicating information should not exceed the benefits to be derived from it.

(So your girl is asking you for a million dollar ring?  Think of the benefit you will receive dude. Don't dish out a million bucks if you won't get anything of value in return... Says accounting)



Accrual Basis

Under the Accrual Basis of Accounting, the effects of transactions and other events are recognized when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of periods to which they relate. Under accrual basis of accounting, income is recognized when earned and expenses are recognized when incurred regardless of when cash is received or paid.

Historical Cost Principle

According to this principle, the value of an asset is to be determined on the basis of acquisition cost. However, this concept is not always maintained. Some PFRSs require the departure from this concept, such as when inventories are measured at net realizable value (NRV) rather than at cost when applying the “lower of cost and NRV” or when held for sale assets are measure at fair value less costs to sell rather that at cost when applying the “lower of cost and fair value less costs to sell”

(You purchased an iPhone X for a thousand bucks? That's its historical cost. Apple slowed the darn thing down after a year and is now valued at 500 dollars? That's the Net Realizable Value.)

Concept of Articulation

All of the components of a complete set of financial statements are The preparation of a worksheet (and the eventual completion of the financial statements) recognizes that the financial statements are fundamentally interrelated and interact with each other.

(Just like how the Marvel multiverse is interconnected to our beloved Earth and how the Avengers are interrelated with the safety of our world.)

Full disclosure principle

This principle recognizes that the nature and amount of information included in the financial reports reflect a series of judgmental trade-offs. The trade-offs strive for sufficient detail to disclose matters that make a difference to users, yet sufficient condensation to make the information understandable, keeping in mind the costs of preparing and using it.

(ex. When your girlfriend asks you where you are, you just don't mention the place, you also mention who you're with and what you're going to do.)

Consistency concept

The financial statements should be prepared on the basis of accounting principles which are followed consistently from one period to the next. Changes in accounting policies should be made only when required or permitted by PFRSs or when the change would result to more relevant and reliable information. Changes in accounting policies should be disclosed in the notes.

(ex. So, you bought her flowers the day before? Surprise her again today and make her day brighter. Be consistent in doing it. If a change in routine needs to be made, explain it to her. Disclose it. Tell her, babe, I no longer have money to buy you flowers because I deposited it in a joint account for our future.)

Matching (Associating cause and effect)

Costs are recognized as expenses when the related revenue is recognized.

(ex. Inventory is considered as an asset. But if it is sold to generate revenue, it is already considered as an expense.)

Entity theory

The accounting objective is geared towards the proper income determination. Proper matching of costs against revenues is the ultimate end. This theory emphasizes the income statement and is exemplified by the equation: ASSETS = LIABILITIES + CAPITAL

Proprietary theory

The accounting objective is geared towards the proper valuation of assets. This theory emphasizes the importance of the balance sheet and is exemplified by the equation ASSETS – LIABILITIES = CAPITAL

Residual equity theory 

this theory is applicable when there are two classes of shares issued, ordinary and preferred. The equation is “Assets – Liabilities – Preferred Shareholders’ Equity = Ordinary Shareholders’ Equity.” This theory is applied in the computation of book value per share and return on equity.

Fund theory

The accounting objective is neither proper income determination nor proper valuation of assets but the custody and administration of funds. The objective is directed towards cash flows exemplified by the formula “cash inflows minus cash outflows equals fund.” Government accounting and fiduciary accounting are examples of the application of this concept.

(ex. Your salary (cash inflow) - your expenses for your girlfriend (cash outflow) = Zero. If there's something left, well, it's a miracle.)

Realization

The process of converting non-cash assets into cash or claims to cash. It is also the concept that deals with revenue recognition.

Example: Realization occurs when goods are sold for cash or account receivable or when fully depreciated equipment is sold in exchange for a note receivable. Notice that the goods and the equipment are non-cash assets and they were converted into cash or in the case of the receivables, claims to cash.

Prudence (Conservatism)

The inclusion of degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainly, such that assets or income are not overstated and liabilities or expenses are not understated. In other words, when exercising conservatism over conditions of uncertainty, the one which has the least effect on equity is chosen.

(When you're courting Emma Watson, you don't assume that she's digging you right away. If you're joining The Voice, you don't go into the competition expecting that you're going to defeat all the other contestants easily. You don't purchase stocks for the first time thinking you'll become a millionaire in an instant. In other words, don't be a cocky bastard.)