Accounting Principles: Meaning and Explanations

 

In a bid to reconcile the differences created by different approaches used by Companies, Organisations and other establishments in the presentation of their financial statement, accounting principles were introduced.

What Is Accounting

Accounting is the recording, measurement, processing, storing, sorting, presenting, analysing, summarizing, communication of financial transactions and information on the economic activities of an organisation in a useful way for presentation in a future date.

 

What is Accounting Principles

Accounting principles are the generally accepted rules, guidelines, principles that must be followed in accounting and when reporting financial data. These principles were developed through common usage.

 

Basic Accounting Principles

The following are basic accounting principles that have been developed to be followed when preparing accounting information or data.

1. Accrual principle. This is a principle in accounting which states that accounting transactions must be recorded in the accounting period in which the transaction occurred not recording it when the actual cash flows associated with the transaction occurs. This means that whether the cash flow associated has been received or not, the transaction should be recorded in the period it occurred. Accrual Principle helps to show what happened in a given accounting period. Example recording expenses or revenue when the cash is received or paid for instead of when the revenue or expenses was generated or paid for which may even enter into another accounting period.
   
   
2. Conservatism principle. This principle does not direct accountants to be conservative in their dealings rather it helps the accountant to be objective or unbiased in their decisions. When accountants are faced with an alternative when reporting a transaction, conservatism requires them to choose the transaction that will generate less gain. It helps accountants to play safe, anticipate future losses rather than future gains. For example, an accountant can write inventory down to an amount lower than it's original cost, but they are not allowed to write inventory up to an amount higher than it's original cost. Also potential losses from a lawsuit can be reported in notes in the financial statement but the potential gains to such lawsuits cannot be reported.
   
   
3. Consistency principle. This principle states that once an accounting principle or method of reporting has been chosen for your business, it must be consistently used throughout the periods until a new principle is introduced. If the accountants do not follow a particular principle, it makes a long term financial decision-making to be difficult.
   
   
4. Cost principle. Cost refers to the initial amount paid whether in cash or cash equivalent to buy an item in any year it was purchased which may be one hundred years ago. This principle state that a company, business, or organisation should record their assets, liabilities, equity and investments at the original cost it was purchased or sold. Though the value of such may change after a period due to depreciation or inflation, but will not be reflected for accounting reporting purposes. This principle is becoming obsolete because most accounting standards are bringing up adjustments that will take care of such transactions.
   
   
5. Economic entity principle. This principle refers to the practice of treating or keeping the transactions of a business separate from those of its owners and other businesses. It means treating a business as a legal entity different from its owners.
   
   
6. Full disclosure principle. This principle requires full disclosure in the financial statement of all information that will be needed by the readers and users. Any disclosure that cannot be done on the face of the financial statement should be disclosed on the notes to the financial statements.
   
   
7. Going concern principle. This principle states that a business will continue in operation, carry out its objectives, commitment and not go into extinction for the foreseeable future. It means that expenses like depreciation can be split to the next accounting period instead of recognising them at once. The accountant is under obligation to disclose any business entity that shows through its financial statement that it may not continue in operation.
   
   
8. Matching principle. This principle states that every revenue should be matched with related expenses. Further explained, when you record revenue, you should record all related expenses at the same time. Inventory should be charged to the cost of goods sold at the same time that you record revenue from the sale of that inventory.
   
   
9. Materiality principle. This principle states that an item or amount is considered material if its inclusion or non-inclusion in the financial statement will to a reasonable extent affect or influence the decision making of users of the financial statement. Professional judgement is required to decide whether an amount or item is insignificant or immaterial.
   
   
10. Monetary unit principle. This is principle states that a business should record only transactions that can be stated in terms of a unit of currency acceptable in that country. This principle enables a business entity not to engage in a high level of estimation while deriving value for its assets and liabilities. 
    
    
11. Reliability principle. This principle states that only those transactions that can be proven should be recorded. For example, a supplier invoice is strong evidence that an expense has been recorded. This principle will be appreciated by auditors who are always looking for evidence to support a transaction.
    
    
12. Revenue recognition principle. This principle states that revenue should be recognized as soon as the product is sold or services have been rendered. This means that revenue occurs when the buyer takes legal possession of the item sold or the service is performed, not at the moment at which cash for the transaction is accepted by the seller. Many accountants and entities utilize the loophole created by this principle to commit fraud, because of this, standards have been set to guide on what constitutes revenue and its proper recognition.
    
    
13. Period principle. This principle states that a business should report its financial statements to a specific period.