ACCOUNTING PRINCIPLES AND CONCEPTS
Generally Accepted Accounting Principles
guidelines, not laws, determined primarily by the
Financial Accounting Standard Board (FASB) and its
predecessor, the Accounting Principles Board (APB)
provide the general framework for determining what
information is included in financial statements and how
this information is to be prepared and presented
Accounting Entity Principle
An accounting entity consists of people, assets, liabilities,
and activities devoted to a specific economic purpose.
Accounting information is developed for clearly
identified accounting entities such as sole
proprietorships, partnerships, and corporations.
o In any of these arrangements, nonrelated business
interests are accounted for separately.
o corporations: accounting entity coincides with the
legal entity
o proprietorships: it is the accounting entity but the
proprietor is the legal entity liable for both personal
and business obligations
Going Concern Principle
assumes that an accounting entity will continue to
operate indefinitely, thus allowing a business to defer
certain costs that are to be charged against the revenues
of future periods (e.g. undepreciated assets, ending
inventories, prepaid expenses)
ignored for firms about to liquidate, with assets being
reported at the current liquidating value and liabilities at
the amount required to settle debts immediately
Time Period Principle
Financial statements are prepared for specific, relatively
brief accounting periods, ordinarily one year, to assist in
decision making and for tax purposes.
fiscal year
o the year chosen for financial measurement
o does not necessarily correspond to the calendar year
but corresponds to the natural cycle of business
activity
In addition to one year, shorter time periods, e.g. one
month, months, and year-to-date, also may be used for
presenting financial reports.
Monetary Principle
money: basic unit of measurement for financial reporting
gives accountants a common denominator for adding
and subtracting heterogeneous transactions occurring at
various times during the life of an accounting entity
allows for the comparison of financial statements
between and within firms
assumes that money is a stable unit of value over time
(unrealistic: money loses value over time)
not all things of value to the organization can be
measured in monetary terms
Historical Cost Principle
involves valuing assets at the original cost of acquiring
them
should consider adjustments for price level changes
(involves the use of price level indices, e.g. prescription
price indices)
an Rx drug $5.00 in 20X1 (base year), 5.25 in 20X2, 5.50
in 20X3
price index in 20X3: 5.50/5.00 x 100=110%
Objectivity Principle
requires unbiased verifiable measurements
The accountant seeks the most objective evidence
available to support financial statements.
o invoices, cancelled checks, bank statements,
inventory counts, deeds and contracts and use of
historical costs
o not possible to prevent accounting data from being
subject to some bias primarily because of the
existence of alternative accounting method and
future uncertainties
Consistency Principle
related to the objectivity principle
requires that a particular accounting technique not be
changed from period to period, thus facilitating
comparison of financial statements over time
On occasion, however, the management will change to a
different accounting method when the change will serve
the needs of the users of the statement, e.g. change in
depreciation method from linear to sum of years digit
method.
Conservatism Principle
related to the objectivity principle
requires the selection of accounting method that neither
overstate nor understate the facts
However, accounting takes place in an environment of
uncertainty. Thus, where doubt exists, the accountant
selects the option that produces the lower net income
and less favorable financial position.
Use of historical cost is an example of conservatism.
Materiality Principle
refers to the relative importance of an item
An item is considered to be material if it significantly
affects the financial statements, thus influencing the
decisions of prudent users of the statements.
Accounting transactions too small or insignificant to
affect user actions are recorded as is most expedient,
thus saving the expense of initiating a more expensive
accounting procedure.
Materiality of an item depends not only on the amount
but also on the nature of the item. Purchase of a spatula
is an expense not an asset for depreciation.
Full Disclosure Principle
requires that all relevant facts concerning the financial
position of a business be presented in the financial
statements
o even significant events occurring after the end of the
fiscal period, but before release of the financial
statements
 ACCOUNTING PRINCIPLES AND CONCEPTS
Full disclosure can be accomplished either in the body of
a financial statement or in its footnotes.
Realization Principle
fundamental in the accrual basis of accounting
revenue is recognized when it is realized, i.e. when the
earning process is complete and when objective evidence
exists as to the amount of revenue earned; (at the time
goods are sold or services rendered)
Matching Principle
the measurement of an expense occurs in two phases
1st phase
o involves measuring the cost of goods and services
consumed or expired in the process of generating
revenue
2nd phase
o considers matching cost and revenue
o involves determining when the goods and services
acquired have contributed to revenue, at which
time their cost becomes an expense
Independent CPA Opinion
An audit opinion is issued by independent CPAs after they
have audited the financial statements and accounting
records of a business.
published as part of the companys annual report
Standard wording that consists of two paragraphs has
been developed.
o 1st: describes the scope of the examination
o 2nd: presents the actual opinion
We have examined the Balance Sheet of
_______Pharmacy as of December 31, 200X and the related
statements of income, retained earnings and changes in
financial position for the year then ended. Our examination was
made in accordance with generally accepted auditing
standards, and accordingly included such tests of the
accounting records and such other auditing procedures as we
considered necessary under the circumstances.
In our opinion, the above financial statement presents
fairly the financial statement position of _____Pharmacy as of
December 31, 200X and the results of its operations and the
changes of its financial position for the year then ended, in
conformity with generally accepted accounting principles
applied on a consistent basis.
may also include comments on any unusual factors in the
financial position
The primary responsibility for the accuracy of the
financial statements belongs to the management.
CPAs task: to render an opinion as to the fairness of the
presentation
o his independent status is as important as his
technical competence in accomplishing the auditing
task