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12 Basic Accounting Principles and their impact on Financial

Statements

Assignment

Fazul-ur-Rehman Narejo,
Student, MBA-Evening
Registration ID. 1635380

Supervised by:
Mr. Asif Khan

Semester:
Fall 2016

Shaheed Zulfiqar Ali Bhutto Institute of Science & Technology (SZABIST)

Table of Contents

1.

Introduction............................................................................................................ 3

1.1

Accounting Principles.............................................................................................. 3

1.2

Financial Statements............................................................................................... 3

2.

Principles and their impact on Financial Statements.......................................................3

2.1

Time Period Principle.............................................................................................. 3

2.2

Accrual Principle.................................................................................................... 3

2.3

Conservatism Principle............................................................................................ 4

2.4

Consistency Principle.............................................................................................. 4

2.5

Cost Principle........................................................................................................ 4

2.6

Economic Entity Principle........................................................................................ 4

2.7

Full Disclosure Principle.......................................................................................... 4

2.8

Going Concern Principle.......................................................................................... 4

2.9

Matching Principle................................................................................................. 5

2.10

Materiality Principle................................................................................................ 5

2.11

Monetary Unit Principle........................................................................................... 5

2.12

Reliability Principle................................................................................................ 5

3.

Conclusion.............................................................................................................. 5

References.................................................................................................................. 6

1. Introduction
1.1 Accounting Principles
Field of Accounting is governed by various concepts, rules, and principles that harmonize
companies operations with standards accepted widely and globally. These leading principles
guide companies from groundwork of starting a business to more complicated and legalistic
accomplishments. Generally Accepted Accounting Principles, abbreviated GAAP, entails
such principles and rules that assist sequential flow of companies accounting operations. If
for example a company prepares its financial statements at some period in time then it would
need GAAP in order to make it sure that Financial Statements serve valid and consistent
standardized purposes of stakeholders that do not lead to any misrepresentation or
misunderstanding.
1.2 Financial Statements
Financial Statements represent companies position not individually but also in comparison
with its competitors and in overall industry. Therefore, financial statements ought to be as
perfect and error free as possible in correspondence with accounting principles. Else,
companies can face various complications including lawsuits and bankruptcies.
2. Principles and their impact on Financial Statements
Following accounting principles have been identified and accordingly explained briefly in
connection with their effects of Financial Statements
2.1

Time Period Principle


In connection with Financial Statements, this principle states that a business shall report
the results of its operations over a particular period of time. Since financial statements
exhibit position of a business therefore this principle helps decision makers compare
the performance of a business over such periods of time or in other words it helps to
analyse the trend of a business with the passage of months, quarters and years.

2.2

Accrual Principle
In accrual basis of accounting, this principle states that the record of any transaction
shall be made exactly at the time of its occurrence rather than recording same at the
happening of cash flows in association with such transaction. For example, if
accountants ignore the accrual principle then recording of expense will only be done
at the time of payments made which may lengthen the process of reporting in
financial statements therefore it would lead non-compliance of Time Period Principle.

Further, this principle helps decision makers to see, identify, and evaluate what
exactly and actually happened during a particular accounting period.
2.3

Conservatism Principle
This principle suggests accountants that a transaction pertaining to expenses and
liabilities be recorded as soon as possible whereas the record of revenues and assets
be made only when they actually occur. In this sense, this principle proposes to record
losses earlier, not at later stages. Subsequently, it would report lower profits in
financial statements at an earlier accounting period

2.4

Consistency Principle
In this principle, it is stated that business must comply the same accounting principles
that they have adopted first. This principle discourages practice that involves jumping
off from one accounting treatment to another. If not followed, this principle states
that, financial statements would never consistent and would hardly judge the status of
a business in connection with its history. Therefore, financial statements would never
help decision makers to compare and evaluate the operations of a business over
different periods of time

2.5

Cost Principle
This principle states that accountants should record assets, liabilities, and equity
investments of a business at their original cost of purchase. In result, financial
statement would help decision makers analyse liquidity and profitability of a
business. The accounting profession has been willing to move away from the cost
principle if there are reliable, verifiable, and objective amounts involved. For
example, if a company has an investment in stock that is actively traded on a stock
exchange, the company may be required to show the current value of the stock
instead of its original cost.

2.6

Economic Entity Principle


In this principle it is suggested that one business must be separated from personal
transactions of its owners and other businesses. This prevents difficulties caused in
Financial Statements if not followed. Because of the economic entity
assumption, only the assets, liabilities, and owner's equity specifically identified with
companys Service are shown. The personal assets of the owner are not included on
the company's balance sheet.

2.7

Full Disclosure Principle


This principle directs that a business firm should include all the necessary
information, e.g. foot notes, explanations, that helps readers to understand financial
statements.

2.8

Going Concern Principle


This principle states that a business does not limit its life of operation to a certain
period of time rather a business must consider itself to remain in business in future. In
this sense, deferring expenses in financial statements for example depreciation would
be justifiable. For example when the cost of the insurance that has not yet expired
remains on balance sheet is "deferred" in the asset account Prepaid Insurance.
Deferring insurance expense to the balance sheet is possible because of guidelines of
this principles.

2.9

Matching Principle
In Accrual basis of accounting only, this principle states that expenses related to a
revenue should be recorded at the same time. For example accountants, following this
principle, record revenue earned from sale and charge inventory with cost of goods
sold at the same time. If for example the Supplies account shows the cost of supplies
that were obtained by a company but have not yet been used. As the supplies are
consumed, their cost will be moved to the Supplies Expense account on the income
statement. The cost of the unused supplies remains on the balance sheet in the asset
account Supplies. Whereas expenses to be matched either with revenues or with the
time period when they are used.

2.10 Materiality Principle


This principle proposes that if a transaction does not affect decision making of readers
of Financial Statements then that transaction shall not be recorded. However, every
transaction that if not recorded would change the decision must be recorded
2.11 Monetary Unit Principle
This principle states that accountants should only record transactions that can be
stated in terms of a unit of currency. Thus, it is easy enough to record the purchase of
a fixed asset, since it was bought for a specific price, whereas the value of the quality
control system of a business is not recorded. If for example ABC Company were to
purchase a piece of land, the monetary unit assumption dictates that the purchase
price of the land bought today would be reported as the total cost of land.

2.12 Reliability Principle


This principle emphasizes that the transactions that can be justified or proven should
be recorded. For example recording a transaction for purchase of an asset supported
with invoice or bill is a transaction with evidence or prove. This is helpful in
justifying all financial statements especially when audit is being done
3. Conclusion
Financial Statements in connection with basic accounting principles must comply with
consistency and reliability in order to meet standards. This help companies achieve its objectives
in response to fair practices.

References
Accounting Principles (Explanation). (2016). Retrieved from Accounting Coach:
http://www.accountingcoach.com/
Basic Accounting Principles. (2016). Retrieved from
http://www.accountingtools.com/.