Whether you are running a large enterprise or handling a small business, accounting principles are the foundation of any business’s financial reporting and recording. These principles help ensure that financial information is clear, consistent, and reliable. Understanding these principles is very important for making informed financial decisions and maintaining accurate financial records.
In this blog, we will provide a comprehensive detail on accounting principles.
What Are Accounting Principles?
Accounting principles are a set of rules that guide how financial transactions should be recorded and reported. They keep the financial statements reliable and consistent so the businesses, stakeholders, and investors get a clear view of the company’s financial situation.
Purpose of Accounting Principles
The main purpose of accounting principles is to create a standard way for recording a company’s financial statements and transactions. This ensures that financial statements are clear, transparent, and to the point, making it easy and trustworthy for investors to analyze necessary information.
Moreover, these principles help businesses avoid mistakes and errors, which helps in building trust with investors, creditors, and regulatory bodies.
Features of Accounting Principles
Types of Accounting Principles
1. Accrual Principle
Here, revenue and expenses are accounted for as and when they happen, not when cash is received or paid. This provides a better reflection of a business’s financial status.
2. Conservatism Principle
This principle suggests that businesses should account for foreseeable expenses and liabilities as early as possible but only account for revenues when they are realized. This prevents the overestimation of a company’s profit.
3. Cost Principle
As per this principle, assets should be accounted for at the original cost and not at their current market value. It prevents companies from unduly inflating their books of accounts with changing asset values.
4. Objectivity Principle
The objectivity principle points to the fact that financial reporting has to be grounded on evidence, which is objective. Each transaction has to be verified with supporting documents, like invoices or receipts.
5. Consistency Principle
This is the principle of maintaining consistency when applying the same accounting procedures for successive periods. This helps compare financial statements on a period-by-period basis.
6. Revenue Recognition Principle
Here, revenue will be recognized only when it’s earned, but not when cash is received. It helps the revenue to be reported in the appropriate accounting period.
7. Economic Entity Principle
This principle dictates that business transactions must be kept distinct from the personal transactions of the shareholders or owners. This assists in keeping proper financial records for the business itself.
8. Going Concern Principle
The going concern principle presumes that a business will keep operating indefinitely, unless there is evidence to indicate otherwise. This principle is crucial in valuing assets and liabilities.
Limitation of Accounting Principles
Although accounting principles are crucial, they do pose some limitations:
1. Subjectivity: There are certain principles, such as conservatism, that need judgment, and judgment can result in subjectivity.
2. Complexity: For small enterprises, implementing certain accounting principles is complicated and time-consuming.
3. Changes in Standards: Accounting principles change with time, so companies need to remain updated and adjust their financial reporting procedures accordingly.
How to Apply Accounting Principles to Your Business
1. Hire a Professional: Make sure that you have a competent accountant or a financial advisor familiar with accounting principles.
2. Use Accounting Software: Use software complying with accounting principles to computerize your financial record-keeping.
3. Review Financial Statements Regularly: Regular reviews of your financial statements can keep you in line with accounting principles.
4. Stay Educated: Continuously learn about updates in accounting standards to ensure that your business complies with the new regulations.
Conclusion
Accounting principles are crucial for keeping financial records accurate and reliable. As a small business owner or a part of a large corporation, you benefit from following these principles because they enable you to have transparent financial statements, comparable ones, and, most importantly, trustworthy statements. By using accounting principles efficiently, you can make informed business decisions while keeping your company financially sound.
FAQs
1. What are general accounting principles?
General accounting principles are the basic rules and guidelines that ensure how businesses record and report their financial transactions. They keep the financial reports consistent and accurate.
2. How many accounting principles are there?
There are various accounting principles, but the most common ones include accrual, conservatism, cost, objectivity, consistency, revenue recognition, economic entity, and going concern.
3. What are the golden principles of accounting?
The golden principles of accounting are the debit and credit rules:
- Debit the receiver, credit the giver (for personal accounts).
- Debit what comes in, credit what goes out (for real accounts).
- Debit all expenses, credit all incomes (for nominal accounts).
4. What is the difference between accrual and cash basis accounting?
Accrual accounting records transactions when earned or incurred, while cash basis accounting records them when cash is received or paid.
5. Why is the going concern principle important?
It assumes the business will continue operating, affecting asset and liability valuation for long-term planning.
6. Can small businesses benefit from accounting principles?
Yes, applying accounting principles helps small businesses maintain accurate records, manage taxes, and make better decisions.
