Concepts and Principles
Useful information
Fundamental characteristics: relevance and faithful representation. Relevance means the information can affect a decision. It may predict future outcomes, confirm earlier evaluations, or do both. Materiality depends on whether omission, error, or obscuring information could affect user decisions.
Using this year's revenue to forecast next year's revenue shows predictive value. Comparing this year's actual revenue with last year's forecast shows confirmatory value because it tests an earlier evaluation. The same information can do both; the distinction follows how it is used.
Faithful representation is complete, neutral, and free from error. An estimate can still be faithfully represented when its nature and limits are explained and its method is applied correctly. Free from error does not mean every estimate is perfectly certain.
Enhancing characteristics: comparability, verifiability, timeliness, and understandability. Consistent methods help comparison. Comparability does not mean making different transactions appear identical.
The fundamental qualities make information useful; the enhancing qualities improve that usefulness. A fast report still misleads if it is biased or irrelevant. Using the same method for similar items helps users distinguish real business changes from measurement changes, while clear presentation keeps material facts from being hidden in unnecessary detail.
Assumptions
Assumption | Apply it |
|---|---|
Entity | Keep personal and business records separate |
Going concern | Assume continuing operations in the foreseeable future without contrary evidence |
Monetary unit | Record events that can be expressed in money |
Time period | Divide operations into reporting periods |
Accrual | Recognize earned revenue and incurred expenses regardless of payment timing |
The entity assumption keeps an owner's private groceries out of business operating expenses so reported profit reflects the business. Periodicity supplies regular results without waiting for the business's life to end. Going concern assumes continued operations without contrary evidence; it does not guarantee that the business can never close.
Principles and constraints
Idea | Meaning |
|---|---|
Historical cost | Use the acquisition cost in course asset-purchase examples |
Revenue recognition | Record revenue when the service is provided or goods are delivered in the course examples |
Matching / expense recognition | Recognize expenses in the period related to the revenue or benefit used |
Full disclosure | Provide relevant policies, explanations, and facts needed to understand statements |
Cost-benefit | Benefits of information should justify preparation costs |
Prudence | Use caution under uncertainty while remaining neutral |
Industry practice | Consider practices and requirements specific to an industry |
Objectivity | Support records with documents |
Substance over form | Represent the economic substance of a transaction |
An invoice supports objectivity because it supplies evidence for a recorded purchase. The cost-benefit test asks whether obtaining more detail is worth its preparation cost; materiality instead asks whether omission or misstatement could affect a decision. Prudence supports careful, neutral judgments rather than deliberately making results look worse.
Apply accrual without confusing cash
Situation | Record |
|---|---|
Service completed, not yet collected | Revenue and a receivable |
Customer pays before service | Cash and unearned revenue |
Expense used, not yet paid | Expense and a payable |
Pay before the benefit is used | Prepaid asset initially |
A laundry shop completes ₱60,000 of paid services and ₱37,000 of uncollected services. It also receives ₱32,000 for services not yet performed. Earned revenue is ₱97,000, while the advance is a liability. The balance-sheet account named Accrued Revenue is a receivable; do not automatically add it to a separately provided revenue total.
The ₱37,000 counts because the service has been performed and a right to collect exists. The ₱32,000 does not count as revenue because the business still owes future work. This is why cash received and revenue earned can differ.
Likewise, December electricity used but paid in January creates a December expense and a payable. January payment settles the obligation; it does not move the cost into January. Matching reports the used benefit in the related period so payment timing does not distort that period's profit.
Avoid these traps
Prudence does not authorize deliberate understatement of assets or overstatement of liabilities. A personal payment is not automatically a business expense. Timeliness means information arrives soon enough to influence a decision, not merely that it has a date. Materiality considers both the nature and size of information.
Sources
FDNACCT Unit 2_Accounting Concepts and Principles_Study Guide.pdf, pp. 1–4
FDNACCT_2526_T1_Quiz #1_1_Questionnaire.pdf, Test III; FDNACCT_2526_T1_Quiz #1_3_Solutions to PS.pdf