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 Fundamentals of Accountancy, Business
Governor Pack Road, Baguio City, Philippines 2600 and Management 1
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268
Email: [email protected]; Website: www.uc-bcf.edu.ph Grade Level/Section:Grade 11- ABM
MODULE 2 – FABM 1 Subject Teacher: Kenny Jones A. Amlos

BASIC ACCOUNTING CONCEPTS AND PRINCIPLES

Learning Objectives:
At the end of this module, learners must be able to:
a) explain the varied accounting concepts and principles in the preparation of financial
statements.
b) explain the impact of the principles and concepts on accounting.
c) Identify the different accounting elements
d) Identify the accounts under each element

BASIC ACCOUNTING ASSUMPTIONS

1. Going Concern Assumption
The underlying assumption in the preparation of financial statements is the going concern
assumption.

Financial statements are prepared on the assumption that the entity will continue in operation
into the foreseeable future without the need or intention to stop operation. If there is
significant doubt that the business will continue in operations (“Going Concern Problem”), the
going concern assumption is foregone and financial statements will be prepared under a
TERMINATING CONCERN basis.

2. The Accounting Entity Concept

An entity is an object of accounting. Accounting presents financial information regarding an
entity. An entity can be a business, a person, an organization or the government.

A business is a separate accounting entity from its owners. Hence, in preparing financial
reports about the business, transactions of the owners are excluded.

3. Periodicity Assumption/Accounting Period Assumption

The periodicity assumption is an offshoot of the going concern assumption. The presumed
indefinite life of the business is broken into distinct equal periods called “accounting
period” over which the financial performance and financial condition of the business are
accounted and reported to users of the financial statements.

Income is not measured from the start-up of business up to its dissolution but is rather
reported every accounting period.

The length of the accounting period can either be weekly, monthly, quarterly, semi-annually,
or annually.

4. Accrual Basis
The concept of accrual is also an offshoot of the accounting period assumption. Under the
accrual method, income are recorded in the accounting period they are earned regardless
of when they are collected whereas expenses are recorded in the period incurred
regardless of when they are paid.

The accrual basis or method of reporting income or expenses has the following terms:
a) Accrued Income – an income that is already earned but is not yet collected
b) Accrued Expense – an expense that is already incurred but not yet paid
c) Deferred Income – an income that is already received but not yet earned
d) Prepaid Expense – an expense that is already paid but not yet

incurred These terms will be discussed and used further on the topic

ADJUSTING ENTRIES
Fundamentals of Accountancy, Business & Management - Page 1 of
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5. Monetary or Measurement Concept
Only financial transactions are recorded and reported in terms of money such as the
PESO. Non- financial information is not recorded but information relevant to users of financial
statements is noted via a memo entry in the books.

6. Realization Concept
Income is recognized when realized or earned. Income is said to be realized when one of ht
contracting party performed his obligation on the contract, thud have established a right to
demand from the other party.

Realization of income from sale of goods

The ownership to the goods transfers to the customer depending on the following shipping terms:
a) Freight on board (FOB) Shipping point- ownership of the goods transfers to the buyer
the moment goods leaves premises of the seller.
b) Freight on board (FOB) Destination- ownership of the goods transfers to the buyer the
moment goods arrive at the buyer’s warehouse.

Realization of income from sale of services

Income from sale of services is realized when services are rendered based on the extent of
completion.

7. Matching Concept
The matching concept relates to the timing of recognition of an expense. It postulates that
expenditures shall be expensed in the accounting period the benefits of the expenditure are
realized by the entity. An expenditure is an outflow of resources or an obligation requiring
future outflow of resources.

Types of expenditure:
a) Capital expenditures- expenditures that benefits future accounting period. These are to
be recorded as ASSETS. Example of this is the purchase of a building. Building can be
utilized for more than one accounting period. Thus, it is to be recorded as an asset.
b) Period expenditures-expenditures that benefits only the current accounting period.
These are to be recorded as expenses. An example of this is pens purchased.
Generally, pens are only to be utilized in one accounting period that qualifies it to be
recorded as expense instead of asset.

8. Cash Basis of Accounting

This is the opposite of Accrual Basis of Accounting. Under this method, income is recorded when
collected regardless of when earned while expense is recorded when paid regardless of when it is
incurred.

9. Duality Concept
In accounting, each transaction is portrayed as a two-ford effect on the elements of
financial statements (refer to module 5 on the list of Elements of Financial Statement). This is
one of the most important basic accounting concepts you must appreciate.

Other Accounting Concepts

10. Conservatism
This is also known as prudence. In case of doubt, assets and income should not be overstated
while liabilities and expenses should not be understated.

11. Disclosure principle

This states that all relevant and material information should be reported.

12. Objectivity principle

Financial statements must be presented with supporting evidence.
13. Monetary unit principle
Amounts are stated into a single monetary unit

14. Materiality principle

In case of assets that are immaterial to make a difference in the financial statements, the
company should instead record it as an expense. Example of this is when a school purchased
an eraser with an estimated useful life of three years. Since an eraser is immaterial relative
to assets, it should be recorded as an expense.

15. Terminating Concern

With the support of strong evidence, the business assumes that the business will cease its
operations. Hence, the going concern cannot be applied.

16. Historical Cost Concept

Fixed assets must be reported in the financial statements on the cost on which they were
purchased. Fixed assets should not be recorded on their market value unless especially when
applying going concern principle.

ELEMENTS OF FINANCIAL STATEMENTS

Types of Major Accounts/Element
An account is the basic storage of information in accounting. It is a record of the increases
and decreases in a specific item of asset, liability, equity, income or expense. An account may be
depicted though a “T-account”.

The Five Major Accounts/ Elements of Financial Statements

1. Assets- the resources you control that have resulted from past events and can provide
you with future economic benefits, which may include: (a) Sold or exchanged for other
assets; (b)Use singly or in combination with other assets to produce goods for sale; (c)
Used to settle a liability; (d) distributed.

2. Liabilities- are your present obligations that have resulted from past events can require
you to give up resources when settling them.

3. (Owner’s) Equity/net assets/ Capital- assets minus liabilities

4. Income- are increases in economic benefits during the period in the form of inflows or
enhancements of assets or decreases of liabilities that result in decrease in equity, other
than those relating to investments by the business owners.

Income includes both revenue and gains

a) Revenue arises in the course of ordinary activities of a business and is referred to by a
variety of different names including sales, fees, interest, dividends, royalties, and rent.
b) Gains represent other items that meet the definition of income and may or may not
rise in the course of the ordinary activities of an economic entity.
Example:
Your business is selling barbeque. The income you derive from selling barbeque is called revenue
because selling barbeque is your main business (ordinary business activity).

One day, you decided to replace your old beach umbrella. The umbrella has a carrying
amount/ book value of ₱2,000 in the accounting books. You were able to sell the old umbrella
for ₱2,200. The difference between the selling price of ₱2,200 and the book value represents
gain. This is because selling of umbrella is your main business (not your ordinary business
activity).

*Any second-hand assets parted with or received should be recorded using the book value
not the fair value.
 5. Expenses- are decrease in economic benefits during the period in the form of outflows or
depletions of assets or increases of liabilities that result in decreases in equity, other than
those relating to distributions to the business owners.
Expenses include both expenses and losses.
a) Expenses arise in the course of ordinary activities of a business.
b) Losses represent other items that meet the definition of expenses and may, or may
not, arise in the course of the ordinary activities of the entity.
Example:
In your barbeque business, the cost of the barbeque you have sold (cost of goods sold) is an
expense.

If you were able to sell the old umbrella carrying amount of ₱2,000 for ₱1,600, the
difference now of ₱400 represents a loss.

CLASSIFICATION OF THE FIVE MAJOR ACCOUNTS

The five major accounts are classified according to the financial statement where they appear as
follows:
BALANCE SHEET ACCOUNTS INCOME STATEMENT ACCOUNTS
Assets Income
Liabilities Expenses
Equity

COMMON ACCOUNT TITLES

The following are the common account titles and their descriptions:

BALANCE SHEET ACCOUNTS

ASSETS
 Cash- includes money or its equivalent that is readily available for unrestricted use, e.g.,
cash on hand and cash in bank.

 Accounts receivable- receivables supported by oral or informal promises to pay.

 Allowance for bad debts- the aggregate of estimated losses from uncollectible accounts
receivable. Another term is “allowance for doubtful accounts”

 Notes Receivables- receivables supported b written or formal promises to pay in the

form of promissory notes.

 Inventory- represents the goods that are held for sale by a business. For manufacturing
business, inventory also includes goods undergoing the process of production and raw
materials that will be consumed in the production process.

 Prepaid supplies- represent the cost of unused office and other supplies.

 Prepaid rent- rent paid in advance

 Prepaid insurance- cost of insurance paid in advance.

 Land- the lot which the building of the business has been constructed or a vacant lot
which is to be used as future plant site. Land is not depreciable.

 Building- the structure owned by a business for use on its operations.

 Accumulated depreciation-building- the total amount of depreciation expenses recognized

since the building was acquired and made available for use.
  Equipment- consist of various assets such as:
a) Machineries and other factory equipment
b) Transportation equipment
c) Office Equipment
d) Computer equipment
e) Furniture and fixtures

 Accumulated depreciation-equipment- the total amount of depreciation expenses

recognized since the equipment since the equipment was acquired and made available for
use.

*Collectively, land, building, and equipment are referred to as “Property, Plant, and Equipment” or
“Capital Assets”, “Fixed Assets”.

LIABILITIES
 Accounts Payable- obligations supported by oral or informal promises to pay by the debtor.

 Notes Payable- obligations supported by written or formal promises to pay by the debtor
in form of promissory notes.

 Interest Payable- interest incurred but not yet paid. Interest payable arises from
interest- bearing liabilities. For example, you will incur interest on our bank loan.

 Salaries Payable- salaries already earned by employees but not yet paid by the business.

 Utilities payable- utilities (electricity, water, telephone, internet, cable TV, etc.) already
used but not yet paid.

 Unearned income- items related to income that were collected in advance before they
are earned. After the earning process is completed, these items are transferred to income.

*The word “receivable” connotes an asset while the word “payable” connotes a
liability.
*The word “prepaid” connotes an asset while the word “unearned” connotes a liability.

EQUITY (Capital, Net Assets or Net worth)

 Owner’s Capital (or Owner’s Equity)- the residual amount after deducting liabilities from
assets.

 Owner’s Drawings- this account is used to record the temporary withdrawals of the
owner during the period. At the end of the accounting period, any balance in this account
is closed to the “Owner’s capital account”.

INCOME STATEMENT ACCOUNTS

INCOME
 Service fees- revenues earned from rendering services

 Sales- revenues earned from the sale of goods

 Interest income- revenues earned from the issuance of interest-bearing receivables.

 Gains- income earned from the sale of assets (except inventory) or from enhancements
of assets or decreases in liabilities that are not classified as revenue.

EXPENSES
 Cost of sales (Cost of goods sold)- represents the value of inventories that have been
sold during the accounting period.
  Freight-out- represents the seller’s costs of delivering goods to customers. Other terms for
freight-out are “delivery expense”, “transportation-out”, and “carriage outwards”

 Salaries expense- represents the salaries earned by employees for the services they
have rendered during the accounting period.

 Rent Expense- represents rentals that have been used up during the accounting period.

 Utilities Expense- represents the cost of utilities that have been used during the
accounting period.

 Supplies expense- represents the cost of supplies that have been used during the period.

 Bad debts expense- the amount of estimated losses from uncollectible receivables
during the period. Other term is “doubtful accounts payable.”

 Depreciation expense- the cost of depreciable asset that has been allocated to the
current accounting period.
Formula: (Purchase price-Salvage value) / useful life
*Other formulas will be discussed under the topic “Adjusting Entries”

 Advertising expense- represents the cost of promotional or marketing activities during

the period.

 Insurance expense- represents the cost of insurance pertaining to the current

accounting period.

 Taxes and Licenses- represent the cost of business and local taxes required but the
government for the conduct of business.

 Transportation and travel expense- represent the necessary and ordinary cost of
employees getting from one workplace to another which is reimbursable by the business.

 Interest Expense- represents the cost of borrowing money. It is the price that a lender
charges
a borrower for the use of lender’s money.

 Miscellaneous expense- represents various small expenditures which do not warrant

separate presentation.

 Losses- expenses which may or may not arise from the ordinary course of business activities.
*”earned” relates to income while “incurred” relates to expenses.
*”unused” portion of a cost is an asset while “used” portion is an expense

References:
 Banggawan, R., Asuncion, D.(2017).Fundamentals of Accountancy, Business and
Management 1. Aurora Hill, Baguio City: Real Excellence Publishing.
 Ferrer, R., Millan, Z.(2017). Fundamentals of Accountancy, Business and Management 1.
Bakakeng Sur, Baguio City: Bandolin Enterprise.

Other References you may use:

 Ong, F.(2016). Fundamentals of Accountancy, Business and Management 1. South
Triangle, Quezon City: C & E Publishing.
 Baysa, G., Lupisan, M.(2011). Accounting for Partnership and Corporation. Mandaluyong
City: Millenium books,