Accounting Principles

Accounting principles are the guidelines and general rules that both public and private companies are required to follow when reporting their accounts and financial data.

While no universally accepted accounting principles exist, there are various accounting frameworks which act as the standard body. The most frequently used accounting principle frameworks are IFRS, US GAAP, and UK GAAP. There are several similarities and differences between the three frameworks. While GAAP is more rule-based, IFRS is more principle-based.

Click through to the accounting principles and concepts below to find out more.

  • Industry Practices Constraint
    The industry practices constraint, also referred to as the industry practices concept, states that companies in certain industries can use different accounting practices.
  • Materiality Concept
    The materiality concept states that any transaction that can significantly impact the financial statements should not be ignored.
  • Going Concern Concept
    The going concern concept states that a business will continue its operations for the foreseeable future.
  • Business Entity Concept
    The business entity assumption is an accounting principle that makes a legal distinction between the transactions carried out by a business and the transactions of the owner.
  • Periodicity Assumption
    The periodicity assumption states that a company can report its financial information within certain designated or artificial periods of time.
  • Monetary Unit Assumption
    Monetary unit assumption states that only transactions which can be measured in monetary terms are recorded in a company’s books of accounts.
  • Generally Accepted Accounting Principles (GAAP)
    Generally Accepted Accounting Principles (GAAP) are the rules and accounting concepts that are generally accepted in the United States.
  • Economic Entity Principle
    The business entity or the economic entity assumption is an accounting principle that makes a legal distinction between the transactions carried out by a business and the transactions of the owner.
  • Accrual Principle
    The accrual principle is a very important concept in accounting, and it forms the basis of making adjusting entries during the accounting cycle, which we have covered before.
  • Consistency Principle
    The consistency principle states that once a company adopts a certain accounting policy or method, it must be applied consistently in the future as well.
  • Objectivity Principle
    The objectivity principle in accounting states that the financial statements a company produces must be based on solid evidence.
  • Conservatism Principle
    The conservatism or prudence principle in accounting is the general concept of recognizing expenses and liabilities as soon as possible when there is uncertainty.
  • Cost Benefit Principle
    The cost benefit principle states that the cost of providing the information in the financial statements should not exceed the benefits that the users get from reading those statements.
  • Full Disclosure Principle
    The full disclosure principle states that any information that is useful or can make a difference in decision making should be disclosed in the financial statements.
  • The Matching Principle
    The matching principle is a crucial concept in accounting which states that the revenues and any related expenses are realized and recognized in the same accounting period.
  • Revenue Recognition Principle
    The revenue recognition principle states that a company should record and recognize revenue when it is earned and not when the actual cash proceeds are received.
  • Historical Cost Principle
    The historical cost principle is one of the basic concepts of accounting and bookkeeping.

Importance

Accounting principles are followed to ensure economic information is properly communicated in a language that is understandable and accepted by businesses globally. Companies have to follow these accounting principles when preparing their financial statements.

The characteristics of a company, the company law and other regulations determine which accounting principles they need to follow. The standard accounting principles are also known as Generally Accepted Accounting Principles (GAAP). The framework foundation of accounting concepts, standards, objectives and conventions for companies is provided by GAAP. It serves as a guide on how to prepare and report financial statements.

Why GAAP?

The goal of GAAP is to regulate and standardize accountancy practices by providing a framework to make certain companies and organizations are honest and transparent in their financial reporting. Accounting principles serve as a strict set of rules for accountants when it comes to doing their accounting systems.

Accounting principles make sure companies follow certain standards when it comes to recording how economic events should be acknowledged, recorded, and reported. External stakeholders of a company such as investors, banks & agencies rely on these principles to ensure that accurate and relevant information is provided by a company in their financial statements.

The 10 Basic Accounting Principles

Although several guidelines and principles make up GAAP, but they boil down to 10 basic accounting principles that are most commonly used in the field of accounting.

Historical Cost Principle – The historical cost concept states that the assets and liabilities of a company must be recorded in the accounting records at their historical cost. This is the amount that is paid to purchase the asset and may not be the same as the current market value of the asset. So, the asset remains on the balance sheet without been adjusted for any fluctuations in its market value.

Revenue Recognition Principle – The revenue recognition principle states that a company should only record revenue when it has been earned, not when cash is received. When a company creates an invoice for a customer when goods or services are sold, the money on the invoice is recorded as revenue at that point, and not when the amount is received from the customer. This accrual basis of accounting provides an accurate picture of the company’s financials during the period.

Matching Principle – The matching principle states a company must report an expense on the income statement in the period in which the related revenues are earned. This principle ensures all revenue and expenses are recorded on the accrual basis, working best with the revenue recognition principle. Investors usually want to see a streamlined income statement where revenues and expenses are tied together. By matching them together, investors get a better sense of the financial situation of the business.

Full Disclosure Principle – The full disclosure principle is a concept that requires a company to report and present all necessary information about their financial statements and other relevant information to all individuals who are accustomed to reading this information. This information is disclosed in the footnotes of the financial statement. This way stakeholders such as creditors and investors are not misled by the lack of information.

Cost Benefit Principle – Cost benefit principle states that the benefits of an accounting system that produce financial statements and reports should always outweigh its costs. The cost benefit principle should be considered as part of the decision-making process for all components of the principles of an accounting system.

Conservatism Principle – The conservatism principle recognizes expenses and liabilities when there is uncertainty about the outcome, but only recognizes revenues and assets when their outcome is assured. This helps accountants from underestimating future expenses and overestimating future revenues, which may mislead financial statement users.

Consistency Principle – The consistency principle requires that a company follows the same accounting principles, methods, practices and procedures when making their financial statements from one accounting period to the next. This allows the analysts of financial statements to make meaningful comparisons between several accounting periods. Consistency allows a company to make a change to a more preferred accounting method, but the change and its effects must be clearly disclosed in the financial statements.

Objectivity Principle – The objectivity principle states that the financial statements of a business should be free of any bias and based on evidence. The purpose behind this principle is to keep the accounting department of an organization from producing financial statements that are affected by their opinions and biases. Outside auditors need their organizations to record financial statements under the objectivity principle to make it easier to locate information and conduct the audit.

Accrual Principle – The accrual principle states that accounting transactions need to be recorded in the accounting period in which they actually take place, rather than the accounting period in which the cash flows related to them take place. When successfully implemented, the accrual principle allows the company to aggregate all revenue and expense information for the period, without any delays and distortions occurring from the cash flows in that accounting period.

Economic entity principle – The economic entity principle is an accounting principle that states that an organization’s finances should be kept separate from those of the owner, shareholders, partners or related businesses. Each entity must maintain its own separate accounting records considering its business operations. Subsidiaries and their parent companies are an exception, as they combine their financial statements.

In conclusion

These accounting principles guarantee consistency across all businesses when it comes to accounting reports and financial statements. This, in return, helps protect business owners, investors, and consumers from fraud.