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Home>>AccountingPrinciples

BasicAccountingPrinciples
Anumberofbasicaccountingprincipleshavebeendevelopedthroughcommonusage.Theyformthebasisuponwhich
modernaccountingisbased.Thebestknownoftheseprinciplesareasfollows:

Accrualprinciple.Thisistheconceptthataccountingtransactionsshouldberecordedintheaccountingperiods
whentheyactuallyoccur,ratherthanintheperiodswhentherearecashflowsassociatedwiththem.Thisisthe
foundationoftheaccrualbasisofaccounting.Itisimportantfortheconstructionoffinancialstatementsthat
showwhatactuallyhappenedinanaccountingperiod,ratherthanbeingartificiallydelayedoracceleratedbythe
associatedcashflows.Forexample,ifyouignoredtheaccrualprinciple,youwouldrecordanexpenseonlywhen
youpaidforit,whichmightincorporatealengthydelaycausedbythepaymenttermsfortheassociatedsupplier
invoice.

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Conservatismprinciple.Thisistheconceptthatyoushouldrecordexpensesandliabilitiesassoonaspossible,but
torecordrevenuesandassetsonlywhenyouaresurethattheywilloccur.Thisintroducesaconservativeslant
tothefinancialstatementsthatmayyieldlowerreportedprofits,sincerevenueandassetrecognitionmaybe
delayedforsometime.Conversely,thisprincipletendstoencouragetherecordationoflossesearlier,ratherthan
later.Thisconceptcanbetakentoofar,whereabusinesspersistentlymisstatesitsresultstobeworsethanis
realisticallythecase.
Consistencyprinciple.Thisistheconceptthat,onceyouadoptanaccountingprincipleormethod,youshould
continuetouseituntilademonstrablybetterprincipleormethodcomesalong.Notfollowingtheconsistency
principlemeansthatabusinesscouldcontinuallyjumpbetweendifferentaccountingtreatmentsofits
transactionsthatmakesitslongtermfinancialresultsextremelydifficulttodiscern.
Costprinciple.Thisistheconceptthatabusinessshouldonlyrecorditsassets,liabilities,andequityinvestments
attheiroriginalpurchasecosts.Thisprincipleisbecominglessvalid,asahostofaccountingstandardsare
headinginthedirectionofadjustingassetsandliabilitiestotheirfairvalues.
Economicentityprinciple.Thisistheconceptthatthetransactionsofabusinessshouldbekeptseparatefrom
thoseofitsownersandotherbusinesses.Thispreventsinterminglingofassetsandliabilitiesamongmultiple
entities,whichcancauseconsiderabledifficultieswhenthefinancialstatementsofafledglingbusinessarefirst
audited.
Fulldisclosureprinciple.Thisistheconceptthatyoushouldincludeinoralongsidethefinancialstatementsofa
businessalloftheinformationthatmayimpactareader'sunderstandingofthosefinancialstatements.The
accountingstandardshavegreatlyamplifieduponthisconceptinspecifyinganenormousnumberof
informationaldisclosures.
Goingconcernprinciple.Thisistheconceptthatabusinesswillremaininoperationfortheforeseeablefuture.
Thismeansthatyouwouldbejustifiedindeferringtherecognitionofsomeexpenses,suchasdepreciation,until
laterperiods.Otherwise,youwouldhavetorecognizeallexpensesatonceandnotdeferanyofthem.
Matchingprinciple.Thisistheconceptthat,whenyourecordrevenue,youshouldrecordallrelatedexpensesat
thesametime.Thus,youchargeinventorytothecostofgoodssoldatthesametimethatyourecordrevenue
fromthesaleofthoseinventoryitems.Thisisacornerstoneoftheaccrualbasisofaccounting.Thecashbasisof
accountingdoesnotusethematchingtheprinciple.
Materialityprinciple.Thisistheconceptthatyoushouldrecordatransactionintheaccountingrecordsifnot
doingsomighthavealteredthedecisionmakingprocessofsomeonereadingthecompany'sfinancial
statements.Thisisquiteavagueconceptthatisdifficulttoquantify,whichhasledsomeofthemorepicayune
controllerstorecordeventhesmallesttransactions.
Monetaryunitprinciple.Thisistheconceptthatabusinessshouldonlyrecordtransactionsthatcanbestatedin
termsofaunitofcurrency.Thus,itiseasyenoughtorecordthepurchaseofafixedasset,sinceitwasbought
foraspecificprice,whereasthevalueofthequalitycontrolsystemofabusinessisnotrecorded.Thisconcept
keepsabusinessfromengaginginanexcessivelevelofestimationinderivingthevalueofitsassetsand
liabilities.
Reliabilityprinciple.Thisistheconceptthatonlythosetransactionsthatcanbeprovenshouldberecorded.For
example,asupplierinvoiceissolidevidencethatanexpensehasbeenrecorded.Thisconceptisofprimeinterest
toauditors,whoareconstantlyinsearchoftheevidencesupportingtransactions.
Revenuerecognitionprinciple.Thisistheconceptthatyoushouldonlyrecognizerevenuewhenthebusinesshas
substantiallycompletedtheearningsprocess.Somanypeoplehaveskirtedaroundthefringesofthisconceptto
commitreportingfraudthatavarietyofstandardsettingbodieshavedevelopedamassiveamountof
informationaboutwhatconstitutesproperrevenuerecognition.
Timeperiodprinciple.Thisistheconceptthatabusinessshouldreporttheresultsofitsoperationsovera
standardperiodoftime.Thismayqualifyasthemostglaringlyobviousofallaccountingprinciples,butis
intendedtocreateastandardsetofcomparableperiods,whichisusefulfortrendanalysis.

Theseprinciplesareincorporatedintoanumberofaccountingframeworks,fromwhichaccountingstandardsgovernthe
treatmentandreportingofbusinesstransactions.
RelatedTopics
Whatareaccountingprinciples?
Whatisagoingconcernqualification?
Whatistheprudenceconceptinaccounting?

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