Accounting Principles: What Are They?
Accounting principles are the regulations and standards that businesses and other organizations have to adhere to when disclosing financial information. These regulations standardize the terminology and procedures that accountants must employ, which facilitates the examination of financial data.
Adopted in 167 jurisdictions, the International Financial Reporting Standards (IFRS) represent the most extensively utilized set of accounting concepts. Generally accepted accounting principles (GAAP) are an alternative set of accounting standards used in the United States.
Understanding Accounting Principles' Objectives
Completeness, Consistency, and Comparability:
The primary aim of accounting principles is to guarantee that a company's financial statements are:
- Complete
- Consistent, and
- Comparable over time.
Facilitating Investor Analysis:
By adhering to these principles, companies enable investors to:
- Analyze financial statements more effectively,
- Extract useful information, and
- Identify trends spanning various reporting periods.
Enhancing Inter-Company Comparisons:
Accounting principles facilitate the comparison of financial information among different companies, aiding investors in:
- Evaluating investment opportunities,
- Assessing industry performance, and
- Making informed decisions.
Mitigating Accounting Fraud:
Moreover, adherence to accounting principles serves as a safeguard against accounting fraud by:
- Increasing transparency in financial reporting,
- Enabling the detection of discrepancies or irregularities, and
- Prompting the identification of potential red flags for further investigation.
Principles of Accounting
Accounting standards such as GAAP and IFRS provide a set of rules and guidelines called accounting principles that businesses must abide by when presenting or documenting financial transactions in their books of account. Companies are able to give a true and fair picture of the financial accounts as a result.
The following is a list of the top 6 accounting principles that businesses frequently adhere to:
- The Accrual Principle
- Principle of Consistency
- Principle of Conservatism
- Taking Care of Business Principle
- Equivalency Principle
- Complete Disclosure Guidelines
What Is Meant by Accounting Concepts?
In India, a number of laws must be observed whether driving or walking on the road in order to maintain a smooth flow of traffic. Similar to this, there are accounting guidelines that an accountant must adhere to when documenting accounts or business activities. One could refer to them as accounting notions.
The Basic Accounting Concepts
These are the fundamental concepts or presumptions of the accounting theory basis, which establish specific operational guidelines for an organization's accounting operations. Companies must generate truthful and fair financial accounts by adhering to 13 key accounting concepts.
Business Entity Concept
According to the notion of a business entity, the enterprise is independent of its owner. Put simply, the company and its owners are handled differently for accounting purposes. Any financial contributions made by an owner to the company will be viewed as a liability. Drawings will apply, though, if the owner withdraws funds for personal use from the company. As a result, a company's assets and liabilities are those of the company, not the owner. As a result, rather than the owner's perspective, the accounting records are included in the books of accounts.
Money Measurement Concept
According to the money measurement idea, a company should only keep track of transactions that have a monetary value. This implies that all transactions, including the buying and selling of items, paying rent, covering expenses, generating income, etc., will be noted in the company's books of accounts. Nevertheless, events or transactions such as the inventiveness of the research department, equipment failure, etc., will not appear in the company's books of accounts.
Going Concern Concept
The idea of a "going concern" makes the assumption that a company would carry on with its operations forever. It denotes an assumption that the company will operate for a very long time and won't go out of business very soon. It is among the most crucial accounting presumptions or ideas. This is so that the company can demonstrate the value of its assets on the balance sheet, which is made possible by the going concern idea.
Accounting Period Concept
The idea of an accounting period specifies the amount of time after which a company must complete its financial statements in order to ascertain whether it has made money or lost money during a given period of time. It also specifies the precise situation of the company's liabilities and assets at the conclusion of the given period of time. The organization's many internal and external users routinely use this information for a variety of purposes. A year is the typical time frame for financial statement preparation. The accounting period is this 12-month span of time. An organization is required by the Income Tax Act and the Companies Act, 2013 to prepare its income statements on a yearly basis.
Cost Concept
According to the accounting principle of cost, all assets of a company should be documented in the books of accounts at the time of purchase. This sum also covers any procurement, installation, transportation, and other costs incurred by the business to prepare the asset for use.
Concept of Dual Aspect or Duality
Any business is built on the dual aspect, or duality notion. The idea explains how commercial transactions are entered into the books of accounts. Every commercial transaction has two effects, according to the notion. It should therefore record each transaction twice. Put simply, one transaction will have an impact on two accounts. The Accounting Equation can be used to represent this idea:
Liabilities + Capital = Assets
According to the accounting equation, an organization's total assets are always equal to the total claims made by its owners and other parties. The outsiders' claims are referred to as Liabilities, and the firm's owners' claims are known as Capital or Owner's Equity.
Concept of Revenue Recognition
The realization concept, which is another name for the revenue recognition concept, states that an organization should only record its business revenue when it is realized, not when the company has received the money.
Matching Concept
According to the matching idea, if an organization's expenses are tied to its revenue for a certain fiscal year, then those expenses should be recognized in the same year. To put it simply, if a company generates revenue during one accounting period and incurs related expenses in the subsequent year, the expense will be realized in the same year that the company realizes the revenue.
Full Disclosure Concept
The full disclosure idea asserts, as its name implies, that a company must reveal all relevant information about its financial performance. The reason for this is that a variety of internal and external users, including investors, banks, creditors, management, staff members, financial institutions, etc., use the data included in the financial statements to help them make financial decisions.
Concept of Consistency
According to the consistency idea, an organization's accounting procedures and regulations should be uniform or consistent. This is due to the fact that the accounting data that a company provides through its financial statements is only useful if it enables users to compare the statements of several years or with the statements of other companies.
Concept of Conservatism
The idea of conservatism, often known as prudence, advocates taking precautions when entering transactions in the book of accounts. This idea states that a company should take a deliberate approach and hold off on recording earnings until they are actually realized. On the other hand, it stipulates that the corporation must acknowledge any loss, even if it hasn't happened yet or if there's a remote chance it won't. Regardless of how gloomy this idea may seem, it is necessary for a company to manage uncertainty and enable them to safeguard creditors' interests from any unwarranted asset distribution.
Concept of Materiality
According to the materiality idea, an organization should only pay attention to material facts. Put another way, a company shouldn't waste time on unimportant details that don't affect how much money it makes this quarter. One should evaluate the nature and magnitude of a fact before classifying it as material or immaterial. Consequently, a fact will be deemed material if the accountant thinks the data has the potential to affect a user of the financial statements' decision-making.
Concept of Objectivity
An organization should record transactions objectively, according to the accounting notion of objectivity. It implies that there should be no prejudice of any type on the recording from accountants or other parties. When the company's transactions are backed by authenticated receipts or other paperwork, objectivity in the transaction recording process is achievable.
The Final Word
Accounting principles are set standards and directives that businesses have to follow when disclosing financial information. The approach a business takes initially, or modifies later, ought to make good financial sense. The main objective of these principles, which go by different names such as IFRS in other countries and GAAP in the United States, is to increase transparency and essentially make it simpler for investors to compare the financial statements of various organizations.