What Are The Principles Of Accounting?
Principles of accounting are general rules and guidelines that companies must follow in reporting all accounts and financial records.
There are different accounting systems that establish a standard body.
The most common systems of accounting principles are IFRS, UK GAAP, and US GAAP.
There are both similarities and differences between these three systems, with GAAP being more rule-based while IFRS is more principle-based.
Importance Of Principles Of Accounting
The goal of having and abiding by the principles of accounting is to be able to communicate economic information in a language that is acceptable and understandable to the business.
Companies that publish financial information are required to follow these principles in preparing their accounts.
Depending on the characteristics of the company or organization, company law and other regulations determine which accounting principles they must apply.
The standard accounting principles are collectively known as Generally Accepted Accounting Principles (GAAP).
GAAP lays the foundation for accounting standards, concepts, objectives, and conventions for companies, acting as a guide for preparing and presenting financial statements.
Examples of accounting principles
There are some core accounting principles and guidelines listed under U.S. GAAP:
- Conservatism principle – In situations where there are two acceptable solutions for reporting an item, the accountant should ‘play it safe’ by choose the less favourable outcome. This concept allows accountants to anticipate future losses, rather than future gains.
- Consistency principle – The consistency principle states that once you decide on an accounting method or principle to use in your business, you need to stick with and follow this method throughout your accounting periods.
- Cost principle – A business should record their assets, liabilities and equity at the original cost at which they were bought or sold. The real value may change over time (e.g. depreciation of assets/inflation) but this is not reflected for reporting purposes.
- Economic entity principle – The transactions of a business should be kept and treated separately to that of its owners and other businesses.
- Full disclosure principle – Any important information that may impact the reader’s understanding of a business’s financial statements should be disclosed or included alongside to the statement.
- Going concern principle – The concept that assumes a business will continue to exist and operate in the foreseeable future, and not liquidate. This allows a business to defer some prepaid expenses (accrued) to future accounting periods, rather than recognise them all at once.
- Matching principle – The concept that each revenue recorded should be matched and recorded with all the related expenses, at the same time. Specifically in accrual accounting, the matching principle states that for every debit there should be a credit (and vice versa).
- Materiality principle – An item is considered ‘material’ if it would affect or influence the decision of a reasonable individual reading the company’s financial statements. This concept states that accountants must be sure to include and report all material items in the financial statement.
- Monetary unit principle – Businesses should only record transactions that can be expressed in terms of a stable unit of currency.
- Reliability principle – The reliability principle is used as a guideline in determining which financial information should be presented in the accounts of a business.
- Revenue recognition principle – Companies should record their revenues when it is recognised, or in the same time period of when it was accrued (rather than when it was received).
- Time period principle – A business should report their financial statements (income statement/balance sheet) appropriate to a specific time period.