Principle of Accounting
Accounting principles are the laws and procedures that organizations must obey when presenting financial reports. It is important for all businesses to have basic accounting principles in mind to ensure the most accurate financial position.
In the United States, the Financial Accounting Standards Board (FASB) issued a set of fundamental principles known as Generally Accepted Accounting Principles (GAAP). Following are some basic Accounting principles:
Business Entity Principle
Under this principle or concept, it is essential that a business organization is separate and distinct from its owner or other businesses.
This eliminates the mixing of assets and liabilities among several corporations, which can cause severe problems when a new company’s financial accounts are audited for the first time.
Unit of Measurement Principle
A firm should only record transactions that can be described in terms of a unit of currency. Thus, it is simple to record the acquisition of a fixed asset because it was purchased at a specified price, however, the worth of a business’s quality control system is not recorded.
Going concern Principle
In almost all cases the counting system will create the values on the assumption that the business will continue operating for an indefinite period of time.
This implies you’d be justified in postponing the recognition of some expenses, such as depreciation, to later periods. Otherwise, you’d have to acknowledge all expenditures at once and not delay any.
Objective Evidence Principle or Reliability Principle
All accounting transactions must be properly supported by objective evidence i.e. Purchase invoice bank statements and various kinds of vouchers.
However, in certain cases, we may have to depend upon judgment and estimates for example provision for bad debts depreciation on fixed assets, etc.
Under this principle or concept, all assets acquired by the business are to be recorded at a cost the market value at any moment of time is to be ignored.
A company’s assets, liabilities, and equity interests should all be recorded at their original acquisition prices.
This notion is becoming less applicable as several of the accounting rules shift toward adjusting assets and liabilities to their fair values.
Dual Aspect Principle
This represents the concept of double-entry bookkeeping. Every transaction enters into by a firm has two aspects that are debit and credit.
This principle is the foundation of double-entry accounting and is utilized by all accounting systems to generate accurate and dependable financial statements.
According to the dual aspect concept at any time the total assets of a business are equal to its total liabilities.
Assets = Capital + Liabilities
This is the concept that accounting transactions should be recorded in the accounting periods in which they occur, rather than in the periods in which they generate cash flows. This is the basis for accounting on an accrual basis.
It is critical for the creation of financial statements that accurately reflect what occurred during an accounting period, rather than being artificially delayed or accelerated by the associated cash flows.
Revenues are recognized as they are earned whether money is received or not, and the cost is recognized as they are incurred whether money is paid or not.
For example, if you ignored the accrual principle, you would only record an expense when you paid for it, which may result in a significant delay due to the payment terms for the accompanying supplier invoice.
Revenue Recognition Principle
This is the principle that revenue should be recognized only when the firm has significantly finished the earnings process.
Because so many people have strayed on the outskirts of this idea in order to commit reporting fraud, a multitude of standard-setting bodies has compiled a tremendous quantity of information on what constitutes accurate revenue recognition.
Following are the accounting conventions generally used to interpret the above-mentioned accounting principles:
1. Conservation (Prudence)
This is the principle that expenses and liabilities should be recorded as soon as possible, but income and assets should be recorded only when you are certain they will occur.
This gives the financial statements a cautious bent, which may result in lower reported profits because revenue and asset recognition may be delayed for some time.
This concept, on the other hand, tends to encourage the recording of losses early rather than later. This idea can be pushed too far if a company consistently misrepresents its outcomes as being worse than they are.
This required taking into account all possible losses but ignoring all possible profits (unrealized profits) which may arise due to business activity in the current year.
This is the concept that once you’ve adopted an accounting principle or procedure, you should stick with it until a clearly superior principle or method emerges.
If a company does not adhere to the consistency principle, it may repeatedly switch between different accounting procedures for its transactions, making its long-term financial outcomes exceedingly difficult to determine.
While certain alternatives are equally acceptable, one suitable alternative should be carefully selected and then applied consistently year after year.
This means that size and extent of any amount will influence its treatment financial statements should separately disclose items that are significant enough to affect evaluation or decisions. But if the item or event is material, it may not be disclosed.
This is a somewhat nebulous and difficult-to-quantify idea, which has caused some of the more insignificant controllers to record even the tiniest transactions.
4. Full Disclosure
This is the principle that you should disclose in or alongside a company’s financial statements any information that may affect a reader’s comprehension of those statements. Accounting regulations have substantially expanded on this notion by requiring a massive quantity of informational disclosures.
These concepts are embedded in a variety of accounting frameworks, from which accounting rules control the treatment and reporting of company transactions.
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