Accounting Concepts and Principles: The

Statement of Financial Position and the Income

Statement

Overview
Today's accountant focuses on the ultimate needs of decision-
makers who use accounting information, whether decision
makers are inside or outside the business. Accounting "is not
an end in itself," but is an information system that measures,
processes, and communicates financial information about an
identifiable economic entity (Needles, Belverd, et al, 1999). It
provides a vital service by supplying the information decision-
makers needs to make "reasoned choices among alternative
uses of scarce resources in the conduct of business and
economic activities.”

Accounting being an information system follows basic accounting

concepts and principles. These accounting concepts and
principles are the ground rules that govern how accountants
measure, process and communicate financial information.
These principles have been developed by the accounting
profession over the years to provide a consistent system of
financial reporting in a constantly changing business
environment (Smith, Keith, et al, 1993).
These frameworks assure users of financial statements that the
reports are prepared in specific ways so that they are reliable
and comparable for the usefulness of these reports rests on
their reliability and comparability.

Scenario
Charlotte de Jesus, housewife and full-time mother turned into
a business woman is now aware of the fact that good

Prepared by Marivic Valenzuela Manalo Page 1

knowledge of bookkeeping and accounting is important if she
wants her business to succeed. She is now convinced that a
good working knowledge of accounting is necessary for every
kind of undertaking that specially involves money.

Accounting has evolved over a period of time. During this era

of development, certain accounting rules, concepts and
terminologies have come to be accepted as useful (Anthony,
Hawkins, and Merchant, 2011)
Let us take for example the newly established business of
Charlotte. To keep track of what is happening in her business
operation in order to derive useful information for the
management of her business, she should record the different
activities undertaken by the designer and tailoring shop. In
recording these activities which are called in accounting as
transactions, certain rules must be observed in order to have a
common basis of understanding. These ground rules or
frameworks which have come to be accepted as useful are
necessary to understand the financial reports made by her
friend Vicky. The rules and frameworks underlying the
preparation of financial statements which is the end product of
an accounting system must be understood by Charlotte or
anyone who wishes to be part of the business world.

Users of Financial Statements

Modern decision makers now-a-days also require fast but fairly
valued reports and accurate information. As business entities
grow in size and complexity, transactions that need to be
recorded and summarized also increase exponentially making it
difficult to comply with the various requirements of modern
time’s decision makers. The use of computers and related
technological advancement in this field aided the need of
accounting for easy recording, summarizing and access to
Prepared by Marivic Valenzuela Manalo Page 2
various financial reports and information. But caution must be
exercised in the use of computers since these are merely tools
to be used in the conduct of various accounting jobs.
Computers cannot be a substitute for skilled accountants. The
accountants direct the operations of the computer system to
guarantee that it’s appropriately being utilized to achieve the
objective of proper check and balance to produce fairly valued
financial statements for the company that will be use by
various internal and external users. The following are the
internal and external users of financial statements prepared by
every business entity.

https://www.google.com.ph/search?q=internal+and+external+users
+of+accounting+information
Internal Users
Those who are directly involved in the business enterprise such as:
• Owners. The owner provides the money/capital that the business
needs to begin operations. Through the financial reports, the
owner can properly manage and monitor the business, analyzing
whether or not he/she can expect reasonable return from his/her
investment.
Prepared by Marivic Valenzuela Manalo Page 3
• Management. Managers of business use accounting information
to set goals for the organization, to evaluate the progress made
toward those goals, and to take corrective action if necessary.
• Employees and Labor Unions. The employees that made up the
work force of the company will be interested in information about
the stability and profitability of the company. Through the
financial statements, employees will be able to assess the ability of
the enterprise to provide remuneration, retirement benefits and
other employee opportunities and benefits. Employees and labor
unions may make wage demands based on the accounting
information that shows their employer’s reported income.
Illustration
From our sample business, Charlotte’s Designer and Tailoring Shop,
Charlotte de Jesus is the owner and manager of the business. After
she had been provided by her friend Vicky Del Rosario, an
accountant, of the fairly valued financial reports of the business, she
was able to find out the inflow and outflow of the cash, various
expenses being incurred, and other important information that guided
her in making strategic management decision for the shop.
The employees of the shop on the other hand will feel secure that
they can still be employed in the shop by Charlotte since the shop
generated net income and company is capable in paying their salaries
as seen in the cash flow statement.

External Users
Those who are not directly involved in the operation of the
business such as:
• Investors and Potential Investors. Investors use financial
reports in evaluating what income they can reasonably expect
from their investment.
• Creditors (which includes money lenders, suppliers,vbanks, and
other trade creditors). Potential lenders or current creditors
determine the borrower’s ability to meet scheduled payments.

Prepared by Marivic Valenzuela Manalo Page 4

• Customers. This group is interested in information about the
continuance of an enterprise, especially when they have a long-
term involvement with, or are dependent on the company’s
offerings either in the form of goods or services.
• Taxing Authorities. Local and national government levy taxes
on individuals and businesses. The amount of the tax is
determined using accounting information.
• Government Regulatory Agencies. Most organizations face
government regulation. For example, the Securities and
Exchange Commission (SEC) requires businesses to disclose
certain financial information to the public. The SEC, like many
government agencies, bases its regulatory activity in part on the
accounting information it receives from firms.
• Nonprofit organizations. Nonprofit organizations, e.g.,
churches, most hospitals, government agencies, and colleges,
which operates for purposes other than to earn a profit use
accounting information in much the same way that profit-
oriented businesses do.
• Other users. Consumer groups and the general public may also
be interested in the amount of income that the businesses earned.
Illustration
Who are the possible external users of the financial reports prepared
by Charlotte’s Designer and Tailoring Shop? Vicky and other parties
who may become interested to fund the business with Charlotte can
be potential owner/investor of the business. Joseph General
Merchandising from whom the shop purchased its various sewing
supplies on credit can also make use of the reports to verify whether
the shop is capable of paying its maturing liabilities.
Government agencies and taxing authorities can easily decipher
through the financial reports prepared by Charlotte’s Designer and
Tailoring Shop whether the income tax return filed and paid by
Charlotte is truthful.

Prepared by Marivic Valenzuela Manalo Page 5

And other interested parties can analyze and see how financially
sound and stable Charlotte’s Designer and Tailoring Shop through
the financial reports the business prepared.

With this in mind, let us try to learn and understand that the
basic accounting concepts and principles serve three basic
purposes:
1. They help increase the confidence of financial statement
users that the financial statements are representationally
faithful.
2. They provide companies and accountants who prepare
financial statements with guidance on how to account for
and report economic activities.
3. And they provide independent auditors of financial
statements with basis for evaluating the fairness and
completeness of those statements (Chasteen, l., Flaherty, R.,
O'Connor, M., 1998).

The preparation of the financial reports to be used by both the

internal and external users follows the guidelines, conventions,
and framework set by the Philippine Financial Reporting
Standards (PFRS). Other countries follow the International
Financial Reporting Standards as seen fit in their own country
of jurisdiction.
The Philippine Financial Reporting Standards is made up of
different standards with its corresponding interpretations that
provide the guidelines and principles that would have to be
adhered to in the preparation and presentation of different
items included in the different financial reports prepared by the
company together with all the necessary disclosures. PFRS

Prepared by Marivic Valenzuela Manalo Page 6

allows every business entities to use a unified set of concepts
and principles in order to prepare financial statements.

Basic Accounting Concepts

The accounting concepts discussed in this section are explicitly
and implicitly contained in detail, in the Conceptual
Framework for Financial Reporting as issued by the
International Accounting Standards Board (IASB) on
September 2010.
The Conceptual Framework, according to IASB provides
concepts that underlie the preparation and presentation of
financial statements for external users aimed at meeting
common financial information needs of various users.
This aims to narrow down differences encountered by various
preparers and users of financial statements across countries
around the globe. It also aims to assist accounting standard-
setting bodies in the development of future accounting
standards, as well as the revision of existing accounting
standards.

Entity Concept
For accounting purposes, an entity is the organizational unit for
which accounting records are maintained, e.g., Joseph General
Merchandising. Under entity concept, the business is regarded
as having a separate and distinct personality from that of the
owner/s – generating its own revenue, incurring its own
expenses, owning its own assets, and owing its own liabilities
(Smith, Keith, et al, 1993). This means that the personal

Prepared by Marivic Valenzuela Manalo Page 7

transactions of owners must not be combined with transactions
of the business.

image courtesy of dreamstime.com & clker.com

This concept also requires that an accountant record only those

financial activities that occur between the entity being
accounted for and other parties. Thus, the accounting entity
assumption establishes boundaries or limits as to what
information should be included in the financial statements of a
given company.

What is the meaning of

business transaction?

Prepared by Marivic Valenzuela Manalo Page 8

Business transaction is a business event that can be measured
in terms of money that affects the enterprise. This would give
rise to an exchange between the business and another party:
“value received and value parted with”.
Example
A barber in Cambodia provides service
to a customer by trimming the latter's
hair: “value parted with” by the barber
will be his service and time; and the
“value received” is the payment made
by the client.

Scenario
Chawalit is the sole owner of Lucky Bazaar, a small but
popular store in Thailand that sells different types of items
such as cloths, souvenirs, and school and office supplies. One
day, Kanokwan, one of Chawalit’s customers, came to his store
to pay a debt which arose from her purchase of supplies one
week ago. Chawalit recorded this transaction in the books of
Lucky Bazaar.
The following day, Jane, another regular customer of
Chawalit’s, also came to his store to pay off her debt to the
latter, which arose from a personal loan that he gave to Jane
one month ago. Chawalit did not record this in the books of
Lucky Bazaar. This is because although both debts were
concerned with the same person (Chawalit), the entity concept
of accounting creates a distinction between transactions
concerning the business entity and the owner. Since the loan of

Prepared by Marivic Valenzuela Manalo Page 9

Chawalit to Jane was a personal one, Lucky Bazaar had
nothing to do with it even though Chawalit was its owner.

Going Concern Concept

According to the Conceptual
Framework, financial reports
are prepared with the
assumption that an entity is a
going-concern. In the absence
of information to the contrary,
this concept assumes that the
business is to continue its operations indefinitely. This means
that the business will stay in operation for a period of time
sufficient to carry out contemplated operations, contracts, and
commitments. This non liquidation assumption provides a
conceptual basis for many of the classifications used in
accounting. Assets and liabilities, for example, are classified
as either current or long term on the basis of this assumption.
If continuity is not assumed, the distinction between current
and long term loses its significance; all assets and liabilities
become current. Continuity supports the measurement and
recording of assets and liabilities at historical costs and not at
their liquidation values (i.e., estimated net realizable amounts)
(Dyckman, t., Dukes, Davis, C., 1998).
Scenario
Click Company violated some regulations which resulted in the
company needing to pay large amounts of fines as punishment.
Despite this, the company is still assumed to be in going

Prepared by Marivic Valenzuela Manalo Page 10

concern because it is not likely possible that this would stop the
operations of the business.
On the other hand, if the company faced great financial
difficulties and got tied down with maturing unpaid liabilities,
they could decide to declare the company’s bankruptcy. Since
there is the proof to the contrary (proof that the business may
not continue operations), the company can be considered not in
going concern. But first, it must be disclosed in the Notes to
the Financial Statements stating that the company is no longer
a going concern entity.

Time Period Concept or Periodicity Concept

It is also known as periodicity concept. It divides the life of the
business into regular intervals (usually one year) at the end of
which financial statements are prepared. This means that the
economic activities undertaken during the life of an accounting
entity are assumed to be divisible into various artificial time
periods for financial reporting purposes. For example, it is
assumed that a reasonable report of income earned can be
made annually or quarterly, even though the revenue
generating activities of a business are continuous.
This is the assumption that implies that it is necessary to
measure accounting income for periods of time less than the
life of a firm and that measurement will not be precise but will
be timely and therefore useful (Smith, Keith, et al, 1993).
Timeliness means having information available to decision
makers in time to be capable of influencing their decisions.
This is the reason why business entities produce regularly

Prepared by Marivic Valenzuela Manalo Page 11

interim financial reports other than the official financial
statements prepared at the end of the reporting period. Interim
period refers to a reporting period shorter than one year.
In choosing one year, the business has two options:
• Calendar Year. A twelve-month period beginning with
January 1 and ending December 31.
• Natural Business Year. The length of the fiscal period is
determined by the nature of the business and the frequency of
the need for data regarding the financial condition and
progress of the business. A yearly fiscal period does not start
with January 1 and end on December 31. (e.g., educational
institutions normally follow a fiscal year beginning May 1
and ending April 30).

Scenario
Linh’s Laundry Shop based in Vietnam prepares its financial
statements on a quarterly basis. Linh, its owner, believes that in
order to properly monitor and manage the operations of her
shop, splitting the life of her business into similar-length time
periods for financial statement purposes is necessary. If she
does not prepare her financial reports regularly, she will not
have a readily-accessible and up-to-date source of information
on whether her business is doing well or not, thus she is more
likely to make wrong business decisions..

Prepared by Marivic Valenzuela Manalo Page 12

Monetary Concept
Money is a common unit of measure that we can use to record
economic transactions and prepare financial statements. Under
this concept, money is used as the unit of measure in preparing
the various financial reports of the company. Considering that
business transactions are done in a global perspective,
monetary concept helps accountants in different countries to
prepare the financial statements of the business. For example,
for the ASEAN countries, monetary concept would be in terms
of their different currencies, to illustrate: Peso ( P ) for the
Philippines, Brunei Dollar (B$) for Brunei Darussalam, Riel
for Cambodia, Rupiah for Indonesia, Kip for Laos, Ringgit for
Malaysia, Kyat for Myanmar, Singapore Dollar for Singapore,
Baht for Thailand, and Dong for Vietnam. We can also
consider China’s currency which is Yuan Renminbi and
Indian Rupee for India together with the two observer
countries and soon to be member of the ASEAN, U.S.A.
Dollars ($) for Timor-Leste, and Papua New Guinean Kina
(PGK) for Papua New Guinea.

It is a common belief that everybody understands money—it's

universally available, it’s certainly relevant to financial
transactions and it’s easy to use. But money, (which can be in
different currencies as examples enumerated above), as a
measure of economic activity does not have a constant value
especially in recent years. It is not time in itself that causes the
change in the value of money but economic events, e.g.,
change in government leadership, chaos in the stocks markets,
etc. The stable money concept assumes that, monetary unit of

Prepared by Marivic Valenzuela Manalo Page 13

measure does not change value overtime, even if in fact it does.
The assumption is made in order to ensure objectivity in
reporting data on the financial statements.
Scenario
Elle is the owner of the most popular beauty parlor in the
Philippines. It has been operating for a very long time already,
hence its fame, numerous expansions and populous workforce.
Elle has more than 30 employees in her parlor, which she pays
P12,000 each at the end of every month. These salaries that
Elle gives her staff represent, in terms of money, the services
of her employees in the parlor’s financial statements. The
monetary concept of accounting requires that the different
obligations, resources and properties of the business be
reported in the financial statements at their values in monetary
units.

Cost Concept
Assets, i.e., resources acquired by the business, must be
recorded at acquisition price (i.e., what you have to give up in
exchange for an ownership of an asset) and no adjustments are
to be made on this valuation in later periods.
The cost principle assumes that assets are acquired in business
transactions conducted at arm's length
transactions, i.e., transactions between a
buyer and a seller at the fair value prevailing
at the time of the transaction. For non - cash
transactions conducted at arm's length, the
cost principle assumes that the market value

Prepared by Marivic Valenzuela Manalo Page 14

of the resources given up in the transaction provides reliable
evidence for the valuation of the item acquired (Dyckman, T.,
Dukes, Davis, C., 1998).
The cost principle provides guidance primarily at the initial
acquisition date. Once acquired, the original cost basis of
some assets is then subjected to depreciation, depletion,
amortization, etc. over time to reflect the said assets in the
Statement of Financial Position in a more realistic valuation.
Scenario
On 2010, King Company purchased additional sewing
machines worth for the business in order for the people to work
more efficiently. It cost them ₱40,000 to purchase the
machines. At present, the sewing machines have a fair market
value of ₱23,000. The sewing machines, according to the cost
principle, must be shown at its historical cost or the original
price or the value upon purchase which is the ₱40,000.
After one accounting period, the sewing machines are to be
subjected to depreciation providing the Statement of Financial
Position realistic and fairly - valued amounts. The basis of the
depreciation would still be the historical cost or original cost of
the sewing machines. The Statement of Financial Position
would then show that the carrying value of the sewing
machines would be ₱40,000 less depreciation

Accrual Concept
This concept requires that income be recorded when earned
regardless whether cash is received. And an expense be

Prepared by Marivic Valenzuela Manalo Page 15

recognized when incurred (e.g., when services or benefits have
already been received) regardless whether payment is made.
To apply the accrual concept, accountants have developed the
accrual accounting. The accrual method of accounting attempts
to record the financial effects on a company of transactions and
other events and circumstances in the periods in which those
transactions, events, and circumstances occur rather than only
the periods in which cash is received or paid by the firm. This
means that accrual accounting consists of all techniques
developed by accountants to apply both the accrual and
matching concepts (Needlers, Powers, et al, 1999).
Throughout this book we illustrate the accrual basis of
accounting, Essentially, the accrual basis records expenses
(i.e., cost of items used or consumed in business operations,
e.g., electricity, water, supplies, etc.) when incurred and
revenues (i.e., price of goods sold or services rendered, e.g.,
service income, sales) when earned.
It is also worth mentioning here that other than the accrual
basis, we also have what we call the cash basis of accounting,
which generally records a journal entry upon exchange of cash,
typically does not require many adjusting entries (Dyckman,
T., Dukes, Davis, C., 1998).
Scenario
The following day at Victoria’s Hand and Foot Spa, Victoria
received the electricity bill from Manila Electric Company.
Upon receipt of bill, she immediately recorded it as an
expense. According to the accrual concept of accounting,
expenses must be recorded when incurred, regardless of

Prepared by Marivic Valenzuela Manalo Page 16

whether it has already been paid. In this case, although Victoria
has not paid yet the parlor’s electricity consumption, it has
been already consumed, and therefore it is already an expense
that must be recorded in the books of the business.
This is similar to the previous situation regarding Emily, in
which Victoria recognized her income in the books already
even though payment from Emily has not been collected yet.

Revenue Realization Concept

Revenue or income is the inflow of assets that results from
producing goods or rendering services. Revenue is not earned
all at one point in time. Instead, the earning process extends
over a considerable length of time.
The revenue realization concept provides that income is
recognized when earned regardless whether cash is received.
This means that both of the following conditions are met:
• The earning process is essentially complete;
• An exchange has taken place (Smith, Keith, et al, 1993).
These two conditions for most of the companies are met at the
time goods are sold or services rendered. To wit:
Two points of income recognition:
• Income is considered earned when services are fully
rendered.
• Income is considered earned when goods or merchandise
are fully delivered.

Prepared by Marivic Valenzuela Manalo Page 17

Scenario
Today at Victoria’s Hand and Foot Spa, Emily was feeling
very relaxed and comfortable thanks to the expertise of the
spa’s masseuses. She stayed in the spa for almost the whole
day, and when it was time to pay for her bill, she told Victoria,
the owner, that she will pay for her massage next week instead.
Victoria agreed. Nevertheless, she recorded income from
Emily’s massage in the spa’s books. This is because, according
to the revenue realization concept of accounting, even though
Victoria received no cash yet, she must still recognize revenue
because services were already fully rendered

Matching Concept
This concept states that all expenses incurred to generate
revenues must be recorded in the same period that the income
are recorded to properly determine net income or net loss of the
period. There is a cause-and-effect
relationship between revenue and
expense recognition implicit in this
definition
Revenues are inflows of resources
resulting from providing goods or
services to customers. For
merchandising companies, the main
source of income is sales revenue derived from selling
merchandise. Service firms on the other hand generate revenue
by providing services.

Prepared by Marivic Valenzuela Manalo Page 18

Expenses on the other hand are outflows of resources incurred
in generating revenue. They represent the costs of providing
goods and services. The matching principle is a key player in
the way we measure expenses. We attempt to establish a causal
relationship between revenues and expenses. If causality can be
determined, expenses are reported in the same period that the
revenue is recognized. If the causal relationship cannot be
established, the expense is either related to a particular period.
Allocated over several periods, or expensed as incurred
(Spiceland, D., Sepe, J., 1998).
Scenario
Tommy is the accountant of Happy Corporation. Today, his
boss came to his office, wanting to know the results of business
operations for the month of June. Tommy hurriedly reviewed
his old reports and found the following information regarding
revenues and expenses for the months of May, June and July:
Revenues earned in June and collected in June P 30,000
Revenues earned in June but collected in July 20,000
Revenues earned in May but collected only in June 10,000
Expenses incurred in June and paid in June 10,000
Expenses incurred in June but payable in July 15,000
Expenses incurred in May but paid in June 7,000
With this information, Tommy knew exactly what to do. He
computed for the Net Income or Net Loss by deducting the
total expenses of the period to the total revenue of the same
period. In this case, it is for the month of June. If total revenue

Prepared by Marivic Valenzuela Manalo Page 19

is greater than total expenses, the company’s result of business
operation is a net income. But if total expense is greater, the
result is a net loss.
So, the Net Income for June is:
Revenues (30,000 + 20,000) P50,000
Expenses (10,000 + 15,000) 25,000
Net Income P 25,000
=======
Take note that Tommy only considered the revenues earned
and expenses incurred in June, disregarding the cash
collections and payments.

Verifiability or Objectivity Concept

This principle requires that all
transactions must be evidenced
by business documents free from
personal biases and independent
experts (e.g., CPA) can verify
reports. Verifiability assures financial statements’ users that
information faithfully represents the economic phenomena it
purports to represent. This implies that different independent
and knowledgeable observers can reach consensus, although
not necessarily complete agreement, that a particular depiction
is a faithful representation.
Example: Official receipts, invoices, vouchers, etc.

Prepared by Marivic Valenzuela Manalo Page 20

Scenario
In order to improve Michaela’s laundry shop, she asked one of
her staff to go out and purchase brand new, heavy duty
washing machines. When asked for the receipt, she looks
inside her bag and found out that the receipt was missing. She
replied that she estimates that the cost was around ₱70,000. If
the accountant were to record the amount stated, then it would
be a violation of the objectivity principle since there is no proof
or evidence of such purchase made.

Materiality concept
This concept refers to relative importance of an item or event.
An item/event is considered material if knowledge of it would
influence the decision of prudent users of financial statements.
To illustrate an instance where strict conformity with GAAP is
not necessary because an item is immaterial, consider a low-
cost asset, such as a P150 waste can. This item can be
recorded as an expense in full when purchased rather than an
asset subject to depreciation. The peso amount involved is
simply too small for external users of financial reports to worry
about.
Scenario
Objects such as pencil sharpeners and paper clips, although
they could be beneficial for more than one accounting period,
need not be recorded as an asset that would undergo
depreciation. Hence it could immediately be recorded as an
expense of the company because allocating annual depreciation

Prepared by Marivic Valenzuela Manalo Page 21

for such objects would no longer be material in amount since it
would be insignificant.

Disclosure concept
All relevant and material events affecting the financial
condition/position of a business and the results of its operations
must be communicated to users of financial statements.
We must remember that the purpose of accounting is to
provide information that is useful to decision-makers. So,
naturally, if there is accounting information not included in the
primary financial statements that would benefit users, said
information should be provided to.
Supplemental information is disclosed in a variety of ways
including:
• Parenthetical comments or modifying comments placed
on the face of the financial statements.
• Disclosure notes conveying additional insights about
company operations, accounting principles, contractual
agreements, and pending litigation.
• Supplemental financial statements that report more detailed
information than is shown in the primary financial
statements. (Spiceland, D., Sepe, J., 1998)
Scenario
Star Company is very famous not only in its country of origin
but also internationally for providing the best quality of
electric fans to its buyers. The company is keen in observing
Prepared by Marivic Valenzuela Manalo Page 22
 the proper methods and procedures that must be done. It
strictly follows the disclosure principle and shows in the
Notes to the Financial Statements important details regarding
the business and its operations. From these information
properly disclosed in the Financial Statements and its notes,
the owner, one of the decision – makers that utilize such
crucial information, is able to create sound and wise
decisions in order to further improve the business.

Consistency and/or Comparability Concept

This concept states that once a method is adopted, it must not
be changed from year to year to allow comparability of
financial statements between years and between businesses.
Through application of consistency, comparability of financial
statements across time periods or even within business entities
is achieved. Comparability is the qualitative characteristic that
enables users to identify and understand similarities in, and
differences among financial statement items. Information
becomes more useful if it can be compared with similar
information of other entities or within the same entity for
different periods.
For example if the Periodic Inventory System was used by the
firm in accounting for their inventories, the firm should not
change the method into Perpetual Inventory System in the
following year and then go back again to Periodic on the next
year.
Consistency in this case means that the reported information
conforms to procedures that remain unchanged from period to

Prepared by Marivic Valenzuela Manalo Page 23

period. Comparisons overtime are difficult unless there is
consistency in the way accounting principles are applied across
accounting year.
Scenario
Swap Company is currently using the straight line depreciation
method for computing the depreciation of assets. After some
years have passed, with justifiable reasons, it was decided that
the instead of the straight line method, the double declining
balance depreciation method be used instead. After merely just
one year of operations, they wanted to switch back to the
straight line method.
The first scenario (straight line to double declining balance),
showed that it was still in compliance to the consistency
principle but the second scenario (double declining balance to
straight line) would violate the consistency principle because it
is not allowed that once a new method is adopted, you cannot
revert back to the old method used just a year after or change
methods year after year.

Conservatism or Prudence Concept

This concept states that when uncertainties exist, accountants
lean toward or favor the accounting method that would produce
the lower net income or lower asset valuation. In the presence
of uncertainties, the accounting method with the least impact
on equity is preferred.

Prepared by Marivic Valenzuela Manalo Page 24

Scenario
Divine Wind Company is uncertain as to how specific Asset
and Income items are to be measured, in the presence of
competing alternatives. In the presence of uncertainty, an
understatement of assets or income is preferred rather than an
overstatement.
As mentioned in the foregoing discussions, the Conceptual
Framework sets the overarching principles that are reflected in
the Philippine Financial Reporting Standards (PFRS),
providing the rules and guidelines in the preparation of the
company’s financial reports.
Useful financial information derived from the various financial
reports prepared by various organizations must have the two
characteristics according to the Conceptual Framework. The
first is relevance, which means that the information obtained
from the financial reports are capable of making a difference in
the decision/s made by the user of these reports. The second is
faithful representation, which means that the information to
be provided must be complete, neutral, and free from material
error/s.
Other that these two basic characteristics as provided by the
Conceptual Framework, financial information to enhance its
value to the users of these reports must also have the following
characteristics: comparability, verifiability, timelines, and
understandability.

Prepared by Marivic Valenzuela Manalo Page 25