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.
The principle of accounting is a fundamental rule that helps businesses track their financial position and performance. The principle states that an entity’s financial statement should accurately reflect its financial position and performance.
This includes all assets, liabilities, equity, revenue, and expenses. By following this principle, businesses can make informed decisions about their finances and operations
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.
The business entity principle is important for several reasons. First, it helps ensure that the financial information reported by a business is accurate and reliable. Second, it helps protect the owners of a business from personal liability for the debts and obligations of the business. Finally, it allows businesses to raise capital by issuing securities such as stocks and bonds.
Unit of Measurement Principle
Unit of measurement principle is the accounting principle that states that the unit of measure for an asset or liability is the amount at which the asset or liability is measured in the financial statements.
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.
This notion prevents a firm from overestimating the worth of its assets and liabilities.
The purpose of this principle is to ensure that financial statements are consistent and comparable. This principle is also referred to as the historical cost principle.
Going concern Principle
The going concern principle is one of the most fundamental principles of accounting. The principle states that businesses should be accounted for as ongoing operations, rather than broken up and sold off in pieces. This is because businesses are more likely to be able to continue operations if they are viewed as a whole, rather than as individual parts. The principle is based on the idea that businesses are more likely to be liquidated or wound down if they are seen as failing, which can lead to large financial losses for investors and employees.
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.
By accounting for businesses as a whole, the going concern principle allows for a more accurate view of a company’s financial health and can help prevent premature liquidation.
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.
The accrual principle of accounting is the basis for recording financial transactions in the general ledger. Under this principle, revenue is recorded when it is earned and expenses are recorded when they are incurred, regardless of when the cash is received or paid. This provides a more accurate picture of a company’s financial condition and performance. The accrual principle also allows for better comparisons of a company’s financial results over time.
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.
The revenue recognition principle is a key principle of accounting. According to this concept, revenue should be recognized in the period in which it is earned. The revenue recognition principle is based on the idea that revenue represents income that has been earned from selling goods or providing services. This principle is also based on the assumption that revenues can be reliably measured.
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.
companies must use judgement when applying this principle to ensure that revenue is recognized in the correct period.
The matching principle is one of the fundamental principle of accounting. The principle requires that revenue be matched with the expenses incurred in earning that revenue. In another word, revenue and expenses should be recognized in the same period. The purpose of the matching principle is to ensure that financial statements provide an accurate portrayal of a company’s financial position and performance.
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 concept can be taken too far if a corporation continually misrepresents its results as being worse than they actually 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 several alternatives are equally acceptable, one good option should be carefully chosen and then continuously utilized 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 somewhat nebulous and difficult-to-quantify idea 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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