Beginner's Guide To Accounting Principles

Accounting principles make it possible to record, analyse, verify, and report the business's financial position in a complete, consistent, and comparable manner. It helps stakeholders analyse and extract valuable business information and helps in the comparison of financial information across different companies. However, accounting principles differ across the world.  

In the United States, the Financial Accounting Standards Board (FASB) issues a standardised set of accounting principles referred to as Generally Accepted Accounting Principles (GAAP). Whereas International Financial Reporting Standards (IFRS) issued by International Accounting Standards Board (IASB) are used in over 120 countries. IFRS is a standards-based approach, while GAAP is a rules-based system. One must take proper caution when conducting or analysing financial statements of companies from different countries. 

However, as a business owner, it is essential to have an understanding of basic accounting principles. It is vital as it helps ensure you get the most accurate financial position. There are several principles, but some of them are more notable than others. Let us take a look at 5 basic accounting principles that form the foundation of modern accounting practices – 

Revenue Recognition Principle Historical Cost Principle Matching Principle Full Disclosure Principle  Objectivity Principle  Revenue Recognition Principle

The revenue recognition principle defines how and when revenue is recognised and determines how to account for it. It states that when a company delivers goods or services, the revenue should be recognised in the reporting period in which the goods are delivered, or services are rendered. In the case of accrual basis accounting, revenue is recognised when the services are provided. However, in the case of cash basis accounting, revenue is recognised in the period the cash was received. 

Revenue is the money produced from regular business operations like the sale of goods or services and others' use of enterprise resources, which yields royalties, interests, or dividends. It could be in the form of cash, receivables or other considerations. 

Revenue is the total amount of income generated by the sale of goods or services related to the company's primary operations. Income or net income is a company's total earnings or profit. 

For example, under accrual basis accounting, a marketing agency revenue is recognised when the services are provided even if it has not received payment from the customer for several weeks. 

HistoricalCost Principle 

The historical cost principle states that you should use the historical cost of an item in the books, not the resell cost. The rule means that revenue and expense items are not adjusted to account for changes due to inflation, exchange rates or other changing factors. It is the oldest, simplest of the four principles of accounting. It states that financial statements should be prepared based on how much an asset was worth at the date it was acquired or how much it cost (historical cost). 

For example, equipment that is an asset for business is recorded base on the historical cost and not as per the current fair market value of the asset. 

Matching Principle

This principle requires you to match the expenses incurred in an accounting period with the revenues recognised in that period. The purpose of this accounting principle is to provide information about a company's financial position and performance without any bias or distortion created by recognising revenue before it has been earned or recording expenditures before they have been paid for. In other words, every time something happens where the money goes out of your pocket/business, related income must be reported on your books at around the same time frame. 

For example, suppose you provide consulting service. In that case, you could count the expense of providing the service like expert's salary, overheads, infrastructure cost in the same accounting year at which a customer is served with the services. 

Full Disclosure Principle

The accounting principle of full disclosure means that all information relevant to the subject matter should be disclosed in the financial statements. All transactions are recorded, even if they appear not to affect reported numbers at first glance. Nothing in the financial statement should be misleading. It must disclose all the relevant and reliable information that represents the true and accurate picture of the business finance. 

Objectivity Principle

The accounting principle of objectivity dictates that financial statements should be as free from bias as possible. This may seem like a basic accounting concept, but it can be challenging to achieve in practice because the information recorded by companies is not always objective and unbiased.  

An excellent example of this can be an employee working as an auditor of a company whose prior employer was. In this case, the employee will have some bias for its former company, which might reflect in the audit. 

Conclusion 

Accounting principles are used to record accounting information and financial transactions of an organization. Without accounting principles, businesses would not correctly measure their income and expenses, making it difficult to decide whether to expand or downsize their operation. It also becomes difficult for business owners to manage their money because there would be no clear records on how much cash they have in hand currently. Not every business owner is fluent in accounting principle yet understanding of accounting principle is vital for every business. A fast and a easy way to takcle with accounting process and its principles is to outsource your accounting services to a reputated accounting service provider. With the help of an outsourced accounting service provider, you can conduct your accounting process complying with accounting principles. This will help you find out where your shortages lie so you can put measures in place before it gets too costly.