Accounting principles are essential rules of accounting that ought to be followed in doing account planning and financial statements.
Accounting standards around the world have developed over centuries of business and capital market growth. During this process, accounting standards historically were planned to meet the needs of each nation’s capital markets. Those principles which were found to work well in the legal, educational, political and economic context of each nation became the “generally accepted accounting principles,” (GAAP), for that specific jurisdiction. Naturally, different regulations in different communities led to various accounting principles in each community. (Center for Audit Quality 2009)
GAAP are the currently accepted procedures, principles and standards that business use for financial accounting and reporting all over the world. These rules must be followed by businesses that sell shares to the public - and by any other businesses as well, during preparation of the financial statements . GAAP covers such issues as how to account for inventory, buildings, income taxes and capital stock; how to measure the results of a business’ operations; and how to account for the operations of businesses in specialized industries (for example banking industry or insurance industry). Thanks to GAAP, financial information is clarity for external users.
Accounting Standards are important to protect the interest of investors, managers and the general public by establishing acceptable accounting procedures and the content of financial reports. (B. Cunningham 2015, s. 22)
The most important accounting principles
The best-known of accounting principles are as follows:
- The separate entity or accounting entity or economic entity assumption -a company is an accounting unit isolated from its holders and their individual transactions.
- The continuity or going concern assumption - the conjecture that an enterprise will proceed indefinitely into the future so its assets are not for sale.
- The unit-of-measure assumption - all businesses must be consistently recorded using the same currency.
- Periodicity or the time-period assumption - a company should make reports of the results of its operations over a particular period of time.
- The historical cost principle - accounts record the original cost paid for assets.
- The revenue or realization principle - money is accepted as a revenue when the seller acquires the right to receive payment from the buyer. It happens at the time when goods are sold or when services are supplied.
- The matching principle- revenues and any related costs should be recognized together in the same period. The matching principle is one of the fundamental principles of accounting. This matching of expenses and earnings is crucial for the income statement to show authentic picture of the profitability of a business.
- The objectivity principle - to be reliable, all data recorded and accounting information must be verifiable and objective. It requires no subjective appraisal of replacement values (this means that accounting entries will be based not on individual opinion or beliefs, but on evidence and fact).
- The consistency principle - the same accounting methods or principles that are used in company must be followed from one accounting period to the next.
- The full-disclosure principle - financial reporting must disclose all significant and important information, this can be accomplished by adding significant amount of explanatory notes to the financial statements.
- Materiality principle - only things that would affect knowledgeable user’s choice are important and need to be reported in an appropriate way, if an amount or transaction is negligible.
- The principle of conservatism - where two acceptable accounting methods are possible, conservatism directs the accountant to go for the alternative with the lower profit or lower asset amount.
(R. Hermason, J. Edwards, M. Maher (2010), s.148,262,271; I. Mckenzie (2012), s.18-19)
- Center for Audit Quality (2009), Guide to International Financial Reporting Standards, September 2009.
- Cunningham B. and others (2015), Accounting: Information for Business Decisions, Cengage Learning s. 22.
- Hermason R., Edwards J., Maher M. (2010), Accounting Principles: A Business Perspective, Financial Accounting. Chapters 1 - 8, Open College Textbook, s. 148, 262-272.
- Mckenzie I. (2012), Financial English with Financial Glossary, second edition Heinle, Cengage Learning, s. 18-19.
Author: Marta Mieszczak