What Is Accounting?

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3. Corporation

A business registered as an artificial person under the operation of the law.

PRIMARY ACTIVITIES OF BUSINESSES

1. Servicing

To earn revenue, this business renders services to clients in exchange for a fee.

2. Merchandising

This business engages in the “buying” and “selling” of goods. Its earnings are primarily from the markup (profit) it adds to the cost of goods it sells to the customers.

3. Manufacturing

This business converts raw material into finished goods that are to be sold at selling price.

ACCOUNTING CONCEPTS AND PRINCIPLES

ASSUMPTIONS

➢ Accounting assumptions provide a foundation for the rational and systematic formulation of principles and the development of procedures and method used to perform accounting services.

Five (5) Basic Assumptions in Accounting

1. Economic entity Assumption

Under economic entity, accountants regard a business enterprise as a separate and distinct from the person or people who own and run it. Consequently, a business must keep its own record from the point of view of a business and not to be merged with the personal transactions of the owners.

2. Going Concern Assumption

Assumes that the business entity will continue operating indefinitely for a period of time sufficient to carry out its contemplated objectives, plans, contracts, and commitments unless the liquidation of the entity is imminent.

In view of this assumption, the accountants prepare the value of the FS are based on the accounting conventions of objectivity and historical cost.

3. Monetary unit Assumption

Assumes that money is the common denominator in measuring economic activity. Accounting generally pays no attention to inflation or deflation (price level changes) and assumes that the monetary unit remain stable regardless of fluctuation in money value.

4. Periodicity (time period) Assumption

Assumes that the life of the enterprise is divided into several periods (normally at equal length of time). Thus, when Financial Statements are prepared, it is important to indicate the date when it is prepared and the time period it covers.

5. Accrual-Basis Assumption

Financial Statements, except Statement of Cash Flows, are prepared on the accrual basis of accounting. On this basis, the net profit of a business enterprise is the difference between the revenues and expenses for an accounting period and not the difference between cash receipts and cash disbursements.

Revenues includes not only those cash receipts from revenue transactions during a financial period, but also those income earned but not yet received (accrued income).

Expenses, on the other hand, include not only the cash that a business pays out in this period but also the expenses outstanding (accrued expense).

Basic Principles of Accounting

1. Measurement Principles

Measurement principles guide accountants how assets and liabilities are valued.

a. Cost Principles

❖ Business entities should account for and report many assets and liabilities on at acquisition price. Cost principle adheres to the fundamental qualities of faithful representation and verifiable benchmark for measuring historical trends.

b. Fair Value Principle

❖ Defined as “the amount for which an asset could be exchanged, a liability could be settled, or an equity instrument granted could be exchanged between parties in an arm’s length transactions. It is a market-based valuation and

2. Revenue recognition Principle

As a rule, income is recognized when earned or has been substantially completed, generally at the point of sale. It is because the transfer of title of ownership is made at the point of sale.

a. Earlier recognition principle

b. Later recognition principle

3. Expense recognition principle

Expense recognition principle is synonymous with the matching principle because as a rule, expense is recognized when income is earned.

a. Matching Principle

❖ States that all costs that were incurred to generate the revenue appearing on a given period’s statement of comprehensive income appear as an expense on the same statement.

The expense recognition principle is applied in one of three ways, as follows.

I. Associating Cause and Effect

This is also called direct matching principle because there is a clear and direct relationship that exists between the expense and the associated revenue.

II. Systematic and Rational Allocation

Some assets are useful and can provide benefits to the business over several years. The costs of these assets are expensed over the years they provide benefits to the business.

III. Immediate Recognition

These expenses have no discernible future benefit and so they are expensed immediately as incurred.

4. Full-Disclosure Principle

It requires that financial statements should report all relevant information bearing on the economic affairs of a business enterprise, including subsequent events.

Many items, such as minutes of the meeting and contracts, fail to meet the criteria of recognition but must still be known for relevance and complete reporting. In addition, the report should reveal a transaction’s economic substance rather than merely its form.

Accounting Constraints