Accounting is the backbone of any business, providing a framework for recording, analyzing, and reporting financial transactions. To ensure consistency, clarity, and transparency in financial statements, accountants adhere to specific guidelines known as accounting principles. British Academy for Training and Developing is offering top-notch accounting courses. You can join them and excel in your field like never before. In this blog, we will delve into the 5 basic accounting principles, exploring their definitions, importance, and practical examples.
Accounting principles and examples are the concepts and basic rules guiding the preparation and presentation of financial statements. It maintains uniformity in the financial reporting to facilitate comparison of the same data about different entities over a certain period and to compare and understand financial information across periods and different entities.
There are a variety of reasons main accounting principles exist, including:
Financial statements are prepared consistently over time, which facilitates tracking financial performance.
The principle accounting brings in standard rules that facilitate transparency, thereby establishing trust among the stakeholders.
Investors and management rely on financial reports prepared under these principles to make business decisions.
Accounting principles ensure compliance with laws and regulations related to financial reporting.
Accounting provides the backbone in terms of the provision of financial reports. They ensure that the accountant creates statements that depict a firm's position and its performance. There are five fundamental accounting principles: Revenue Recognition Principle, Matching Principle, Cost Principle, Full Disclosure Principle, and Going Concern Principle. Here is a list of accounting principles:
Revenue has to be considered as earned and realizable according to the revenue recognition principle, as its cash collection is sometimes uncertain whenever it is earned. This usually means that a business operation has to be accounted for if financial statements are to realistically represent the actual performance within a specific period.
Example: A consulting firm receives its revenues at the point in time when it performs the service. When payment is received, that is later in the month of April, no matter is done, since the service has already been rendered in March.
The matching principle establishes that the expenses should be matched with the revenues in the same period. It is through this principle that financial statements will accurately depict profitability.
Example: If a company spends money on advertising to sell a product, then the costs should be expensed in the same period when the sales of the product are recognized. This matching helps stakeholders understand the relationship between expenses and revenues, hence better decision-making.
According to the cost principle, which was also known as the historical cost principle, assets should be recorded at their original purchase price. The principles under this approach stress objectivity and reliability in reporting financial aspects.
For instance, when a firm purchases machinery valued at $50,000, it will carry the asset on its balance sheet at $50,000 even though the market value of the machinery appreciates over time. This implies that financial statements are made on verifiable data rather than estimates or subjective valuations.
The full disclosure principle demands disclosing all information that may affect the understanding of a finance statement by an investor or stakeholder in it. It enhances transparency and aids users of financial statements in decision-making processes.
Example: If a firm is being sued, which might pose significant financial implications to the firm, this should be placed in the notes that accompany the firm's financial statements. This helps ensure stakeholders are forewarned of such risks and uncertainties.
According to the going concern principle, a business will continue operations in the long term; unless and until evidence suggests that this is otherwise. In preparation of statements of financial position, there is always the need to assume it as it brings value both on assets and liabilities.
Example: If the business of a company seems to go through financial constraints but they are likely to carry out its business, the value of its assets is put under the assumption that it will not be sold anytime soon. However, if the company is expected to close down its business then the value of the company's assets is usually taken under liquidation value.
Let's consider a hypothetical company, ABC Corp., and how that company applies its accounting principles to its financial reports. If you want to learn accounting principles and rules read below:
Revenue Recognition Principle. ABC Corp. is offering web development services. Revenues are recognized when a project is completed, but the client may pay at a later date.
ABC Corp. incurred $5,000 in marketing costs in January for introducing a new service. This would be recorded and expensed in January when the new service is introduced and the associated revenues are generated.
ABC Corp. purchased a computer for $1,200. Subsequent changes in the market price of this computer are irrelevant and would be recorded at the purchase price of $1,200 on the balance sheet.
ABC Corp. has a probable lawsuit that would cost $100,000. It puts this in the notes of its financial statements so the investors are aware of the risk.
Even though ABC Corp. has just incurred losses, it can operate for the foreseeable future; thus, it used assets that are valued assuming operations continue.
Here's the list of accounting principles for reference purposes.
Revenue Recognition Principle
Matching Principle
Cost Principle
Full Disclosure Principle
Going Concern Principle
These are the primary framework practices of accountants, hence forming the basis of generally accepted accounting principles, IFRS.
Applying the above simple principles in accounting day-to-day activities, is referred to as principle accounting. The accountant applies the principles in the recording of all financial activities so that they are appropriately recorded and transparent.
Adherence to and application of the principles ensures that the integrity of the financial reports is not compromised but instead retained since these are used as a basis for decision-making by the management, investors, and regulators. If you know about accounting assumptions and principles properly it will help you in many ways.
The basic five discussed above make up the core of accounting, and there's also another set of guidelines and principles that guide the overall accounting practice. For instance:
This states that all accounts should be recorded as their transactions take place, regardless of the receipt of cash. Very much linked to the revenue recognition principle and the matching principle, as well.
his principle means that in the presence of uncertainty of such events, an accountant should recognize an approach that is less likely to exaggerate the income or asset. Such an approach requires instant recognition of expenses and liabilities but after verifying their genuineness so as not to postpone the recognition of revenues and assets.
This principle stipulates that all information affecting the users' decision significantly should be disclosed in the financial statements. If, however, the information is minor and would not affect the users' decisions, it could be omitted.
In addition to these fundamental principles, there are some underlying accounting assumptions and principles that further guide the accounting process. These include:
This assumption is based on the existence of a business that such transactions of the business must be separated from any one of its owners or of other businesses.
In this case, it assumes that every business has different activities that cover a given period, normally in months or years, thereby ensuring proper and timely reporting.
In this case, the assumption stipulates that the financial activity will take place in such a reliable monetary unit without fluctuations.
Accounting principles and rules are complementary concepts that go hand in hand to make up a cohesive system for financial reporting. While the former provides general guidelines, the latter provides specific directions for the application of such principles in practice. In this way, the two ensure that the financial statements produced are not only correct and reliable but also within regulatory standards.
All finance and accounting personnel need to have a solid understanding of the five basic accounting principles. The principles provide a framework for ensuring that financial reporting is orderly, consistent, transparent, and reliable so that one can rely on financial reporting. They provide accountants with the framework for producing reliable and useful information in the form of statements to guide decision-making. You can join various accounting courses in Manchester and polish your skills.
In so doing, whether as an investor, a businessman, or merely a student of accounting, a deep understanding of these principles should provide a solid foundation you can use for effective treading in various forms of financial reporting. Foundational principles in accounting ensure improvement in the business financial landscape even as this latter part of the operation transforms through time.