Accounting Principles - What are accounting principles?
Accounting principles are the general rules and guidelines that companies are required to follow when reporting all accounts and financial data.
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Whilst there is currently no universally standardized accepted accounting principles, there are various accounting frameworks which set the standard body. The most common accounting principle frameworks used are IFRS, UK GAAP, and US GAAP. There are both similarities and differences between these three frameworks, where GAAP is more rule-based whilst IFRS is more principle based.
Why are accounting principles important?
The purpose of having - and following - accounting principles is to be able to communicate economic information in a language that is acceptable and understandable from one business to another. Companies that release their financial information to the public are required to follow these principles in preparation of their statements.
Depending on the characteristics of a company or entity, the company law and other regulations determine which accounting principles they are required to apply. The standard accounting principles are collectively known as Generally Accepted Accounting Principles (GAAP). GAAP provides the framework foundation of accounting standards, concepts, objectives and conventions for companies, serving as a guide of how to prepare and present financial statements.
Why are generally accepted accounting principles needed?
GAAP aims to regulate and standardise accountancy practices by providing a framework to ensure companies and organisations are transparent and honest in their financial reporting. Accounting principles serve as a doctrine for accountants theory and procedures, in doing their accounting systems.
Accounting principles ensure that companies follow certain standards of recording how economic events should be recognised, recorded, and presented. External stakeholders (for example investors, banks, agencies etc.) rely on these principles to trust that a company is providing accurate and relevant information in their financial statements.
Examples of accounting principles
There are some of the main accounting principles and guidelines, listed under US GAAP:
- Economic entity principle - The transactions of a business should be kept and treated separately to that of its owners and other businesses.
- Monetary unit principle - Businesses should only record transactions that can be expressed in terms of a stable unit of currency.
- Time period principle - A business should report their financial statements (income statement/balance sheet) appropriate to a specific time period.
- Historical cost principle - A business should record their assets, liabilities and equity at the original cost at which they were bought or sold. The real value may change over time (e.g. depreciation of assets/inflation) but this is not reflected for reporting purposes.
- Full disclosure principle - Any important information that may impact the reader’s understanding of a business’s financial statements should be disclosed or included alongside to the statement.
- Going concern principle - The concept that assumes a business will continue to exist and operate in the foreseeable future, and not liquidate. This allows a business to defer some prepaid expenses (accrued) to future accounting periods, rather than recognize them all at once.
- Matching principle - The concept that each revenue recorded should be matched and recorded with all the related expenses, at the same time. Specifically in accrual accounting, the matching principle states that for every debit there should be a credit (and vice versa).
- Revenue recognition principle - Companies should record their revenues when it is recognized, or in the same time period of when it was accrued (rather than when it was received).
- Materiality principle - An item is considered ‘material’ if it would affect or influence the decision of a reasonable individual reading the company's financial statements. This concept states that accountants must be sure to include and report all material items in the financial statement.
- Conservatism principle - In situations where there are two acceptable solutions for reporting an item, the accountant should ‘play it safe’ by choose the less favourable outcome. This concept allows accountants to anticipate future losses, rather than future gains.
- Consistency principle - The consistency principle states that once you decide on an accounting method or principle to use in your business, you need to stick with and follow this method throughout your accounting periods.
- Reliability principle - The reliability principle is used as a guideline in determining which financial information should be presented in the accounts of a business.
Accounting principles and Debitoor
A growing business can benefit from an automated accounting system such as Debitoor invoicing software. Debitoor allows a businesses to generate and produce financial reports at any given time. Additionally, it can assist you in managing your accounts and reporting, and help determine the current financial standing of your business.