In this article, we will learn in-depth about the important accounting principles, including its definition, 6 principles, and much more.
What is Accounting Principles?
The Accounting Principles are some practical accounting guidelines that effectively follow the accounting functions and provide clear rules on how financial events and transactions will be recorded and presented.
What are the 6 Important Accounting Principles?
The 6 important accounting principles are as follows:
- Cost Principle
- Revenue Recognition Principle
- Matching Principle
- Full Disclosure Principle
- Objectivity Principle
- Consistency Principle.
1. Cost Principle
Under this principle, the financial statement shows fixed assets on the basis of their historical cost, which is at the price at which they were purchased.
At the current market price, fixed assets are not shown because they are not purchased for trade rather than for long-term use in business.
Cost price means the amount sacrificed for the acquisition of the respective asset and other necessary expenses made available for the business to make the asset usable.
For example, If Tyro International purchases a Building for $400,000, the company initially reports it in its accounting records at $400,000.
But what does Tyro International do if, by the end of the next year, the fair value of the building has increased to $500,000?
Under the historical cost principle, it continues to report the building at $400,000.
2. Revenue Recognition Principle
Under the revenue recognition principle, companies recognize revenue in the accounting period during which the performance obligation is fulfilled.
In a service company, at the time the service is performed, revenue is recognized.
In a merchandising company, when goods are transferred from the seller to the purchaser, the performance obligation is generally fulfilled. The sales transaction is completed at this point, and the sales price is set.
For Example, assume on September 30, Mike’s Dry Cleaning cleans clothes, but until the first week of October, customers do not claim and pay for their clothes.
Mike’s should record revenue in September when the service was performed (satisfied with the performance obligation) rather than when the cash was received in October.
On September 30, in his income statement for the service performed, Mike’s would report a receivable on its balance sheet and income.
On September 30, Mike’s would report a receivable on its balance sheet and revenue in its income statement for the service performed.
3. Matching Principle
It dictates that expenses are matched with revenues, according to the matching principle. In recognizing expenses, accountants follow a simple rule: “Let the expenses follow the revenues.” Thus, the recognition of expenses is linked to revenue recognition.
In the example of dry cleaning, this means that Mike should report the salary expense incurred in carrying out the cleaning service on September 30 in the same period in which it recognizes the revenue from the service. In expense recognition, the critical issue is when the expense makes its contribution to revenue.
This may or may not be the same period of time during which the expense is paid.
If Mike does not pay October the salary incurred on September 30th, it will report the salaries payable on its balance sheet on September 30th.
This expense recognition practice is referred to as the principle of matching or the principle of expense recognition.
4. Full Disclosure Principle
Companies disclose all circumstances and events that would make a difference to users of financial statements, under the full disclosure principle.
If it is not reasonable for an important item to be directly reported in one of the four types of financial statements, it should be discussed in the accompanying notes.
According to the full disclosure principle:
- Any changes in the accounting method should be explained in detail.
- The contingent liability is shown in the Accounts statement.
- Accumulated Depreciation is created.
5. Objectivity Principle
According to this principle, the recording of transactions is carried out through the accountant’s knowledge, experience, and intelligence.
At the time of recording the transaction, the accountant himself considers the relevant & irrelevant.
For example, to use a long period of time in business, a clock, staple machine, punch machine, calculators, etc. are purchased, but since they are lower in price and the value of these assets is relatively lower.
They are relatively smaller at the end of the accounting period. These items will be recorded in the expense account of a particular year at the end of the accounting period, not in assets, although it has been written in the primary account book as assets.
6. Consistency Principle
According to this principle, each and every year, books of accounts are prepared and maintained following the same methodology.
This is because of the comparison between the years and the inter-organization and analysis. Otherwise, it is not possible to acquire a true financial picture.
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