BASIC PRINCIPLES OF ACCOUNTING THEORY
Accounting principles are the rules and guidelines that companies must follow when reporting financial data. The ultimate goal of any set of accounting principles is to ensure that a company’s financial statements are complete, consistent, and comparable. This makes it easier for investors to analyze and extract useful information from the company’s financial statements, including trend data over a period of time. It also facilitates the comparison of financial information across different companies.
These are basic rules for how accounting should be carried out in a right and organized manner.
1. Cost Principle
All the assets should be recorded as soon as they are acquired, whatever the asset may be. Every and any asset acquired should be entered in the records as soon as it is bought. Some assets might depreciate over time. Their cost might differ at a later instance, but the recording of the acquisition must be done right away.
Recording the purchases helps keep the business expenses in track and well organized.
2. Matching Principle
This principle considers all the transactions done under a particular type of revenue as a single unit. It is basically about matching expenses with revenues. This theory holds good only in the accrual method of accounting.
3. Materiality Principle
This principle expects that only monetary transactions that are completed are recorded. If the business is a small one, even small amounts might make an impact on the budget. A minor expense per month, when calculated for a year, might make a significant impact on the budget, and hence should be recorded. A recurring expense that represents less than five percent of the budget need not be recorded as per the Securities and Exchange Commission.
4. Conservatism Principle
Liabilities have a significant impact on any business. It is better to be on the lookout and record potential liabilities not to take the business by surprise. The conservatism principle states that all the existing and potential liabilities must be recorded the instant they are recognized. It will help the business keep an adequate amount of cash ready to pay out the debts. It is the best way that a company can plan for future expenses.
5. Time-Period Principle
It is the concept that a business should report the results of its operation over a standard period. It is aimed at creating a set of variables for comparison over time. It is also useful in trend analysis.
6. Consistency Principle
This concept stresses that once a system of accounting has been decided upon, it should be followed in all the business transactions, and changes to this system are not acceptable. This principle is in place so that the companies do not oscillate between different systems for recording transactions.
Accounting principles also help mitigate accounting fraud by increasing transparency and allowing red flags to be identified. These principles are incorporated into a number of accounting frameworks, from which accounting standards govern the treatment and reporting of business transactions.