October 10, 2020

Basic Accounting Principles

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Basic Accounting Principles

Accounting is a system of continuous and interconnected observation and control over the economic activities of an entity. Afterall, it is impossible to plan the further work of the enterprise without controlling processes. How successful an organization is depends largely on its accounting, for which it is necessary to strictly adhere to all generally accepted accounting principles. 

Accounting is a fairly strict discipline. It is strict in the sense that there are certain accounting principles, non-compliance with which may lead to the fact that its data will be inaccurate, incomplete, incomprehensible to users of accounting information. After all, it is the basis for the management of any business.

Accounting Principles

Accounting principles are part of the Generally Accepted Accounting Principles under which companies in the United States must apply detailed, bright-line rules and provide a standardized definition of these rules. Only full compliance with the considered basic accounting principles makes it possible to effectively and accurately complete management and other decision-making tasks for which accounting information is intended.

Let’s review an explanation of the terms that represent basic accounting principles one should be familiar with. 

Accrual principle

One of the fundamental principles. All transactions in accounting should be displayed at the time they are performed, and not when the expected action from this transaction occurs. For example, you have shipped an item to a customer. This operation should be displayed in accounting at the time of shipment, and not when the expected profit is received. For tax purposes though, some small businesses choose to use cash basis accounting instead of accrual. 

Economic Entity Principle

This is an assumption that requires that activities of the business be kept separate and distinct from the activities of the owner and all other economic entities.

Going concern principle

Accounting can only be carried for a company that sees itself operating in the foreseeable future. In other words, there is no concern that the company will go bankrupt or desires to seize its operations. Since the company does not expect to be closed any time soon, it can defer some of the prepaid expenses. 

Materiality principle

Accounting information is of great value, therefore, when maintaining accounting, care should be taken to ensure that it is presented in substance and is of interest to the user. For example, a multi-million dollar enterprise might be able to expense small asset purchases in one year instead of let’s say five years. This principle also allows to round the numbers even to the nearest thousand or million dollars if the size of the company allows it. 

Time period principle

This basic principle requires the definition and use of the same period of time for the accounting period. This allows the owners and other users of financial statements to analyze and compare data for similar periods of time. It also prompts to provide users of financial statements with timely information. 

Reliability principle

Accounting information must be presented without bias and cannot contain errors. It should be the most accurate and relevant information available and one would need to be able to verify it with objective evidence. 

Basic Accounting Principles

Full disclosure principle

Without exception, all operations taking place in the enterprise must be reflected in accounting and be documented. This information can be presented in the financial statements themselves or the notes that accompany them. 

Conservatism principle

Assessment in the accounting process should be carried out with caution – income and assets cannot be overestimated, while expenses and liabilities cannot be understated. This principle requires the accountant to apply impartiality to the information entered in the financial statement, which allows seeing the information reflected there as reliable. 

Comparability principle

Since accounting should be useful for the management and analysis of activities, the comparability concept dictates a need for standardization of reporting forms for different reporting periods. As one of the basic principles of accounting, comparability indicates that only data that can be compared over several reporting periods can be useful. To do this, it is necessary to create an accounting policy at the enterprise and familiarize all users with it.

Consistency principle

Despite the fact that in some cases accounting principles allow a choice between multiple methods, the enterprise should stick to one. Thus, as with the application of the principle of comparability, it is possible to track the dynamics of enterprise development and make the necessary management decisions based on the information received. If the company decides to change a method, it should be disclosed in the footnotes. 

Monetary unit assumption

Although in the process of doing business, information comes in monetary, physical, and labor indicators, its comparison and analysis can be carried out only using monetary indicators. It is assumed that a single monetary unit (currency) is used in the financial reports. This also helps to follow other principles that are important for decision making – the principles of comparability and consistency.

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Author: Charles Lutwidge

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