Accounting Principles
Accounting is one of the significant parts of a business around which all financial decisions depend. Recording and accounting financial transactions help keep track of the company’s revenues and expenses and the overall economic health and performance. However, if you do not know accounting principles well, it may be hard to record transactions and analyze financials effectively.
What are Accounting Principles?
Accounting principles are the rules and guidelines companies and other bodies must follow when reporting financial data. These rules make it easier to examine financial data by standardizing the terms and methods that accountants must use.
Characteristics of Accounting Principles
It is essential to know the characteristics of the accounting principles. They are as follows:
- Focuses on bringing uniformity and easy understanding of different accounting information.
- Not static. They could change over time as per changes in government legislation, business practices, and the demands of accounting users.
- Vary in different business scenarios and are not applicable universally.
Purpose of Accounting Principles
The purpose of accounting principles is as follows:
- Ensure a company’s financial statements are complete, consistent, and comparable.
- Make it easier for investors to analyze and extract useful information from the company’s financial statements, including trend data over a while.
- Facilitate the comparison of financial information across different companies.
- Help mitigate accounting fraud by increasing transparency and allowing red flags to be identified.
What are the Basic Accounting Principles?
There are many accounting principles that accountants and investors follow to implement appropriate financial processes and make informed decisions, including:
Accrual Principle
It recognizes income and costs when generated or spent, regardless of when cash is exchanged. It guarantees that a company’s financial situation and performance are reflected in its financial statements at any moment.
Conservatism Principle
Revenue and expenses are treated differently under this principle. Businesses should recognize expenses even if there’s the expectation that they’ll be incurred. Conversely, businesses should only record revenue when there’s a deal of confidence that it will be formally paid, often by either an invoice or purchase order.
This principle allows businesses to have a much more conservative financial outlook. Following this principle and over-estimating expenses rather than revenue tends to be better for overall cash flow. It allows an accountant to anticipate losses better and maintain a more careful financial outlook.
Cost Principle
Assets are first documented at their historical cost under the cost principle, assuring financial reporting dependability and impartiality. Adjustments for depreciation or impairment may occur in the future, but the concept prioritizes actual transaction values.
Revenue Recognition Principle
This principle dictates that revenue should be recognized when it is both earned and realizable. It ensures that revenue is not prematurely recognized and reflects the actual value a company has generated.
Consistency Principle
One of the advantages of abiding by the basic principles of accounting is to ensure consistency when reporting financial data. This principle states that accountants should enter all transactions and prepare their financial reporting similarly to reduce the potential for errors or any other discrepancies. Sometimes, a firm changes how it presents or prepares its financials. If this occurs, the business and its accountants are expected to disclose that change and why it was made.
Going Concern Principle
This principle states that a business will meet all of its financial obligations. Going Concern may also refer to a company’s viability to continue to make money and avoid liquidation or bankruptcy. Viable firms should consider going concerns, as it indicates they have the resources and financial stability to continue operating.
When a firm is no longer a going concern, it may mean issues such as credit denial, significant losses, lawsuits, or financial instability. If a company is no longer considered a going concern, it will likely look to liquidate some of its assets.
It is worth noting that the going concern includes the GAAS or Generally Accepted Auditing Standards.
Objectivity Principle
According to the objectivity principle, financial information must be reliable and free of prejudice. It emphasizes the need to rely on objective evidence rather than human judgments to ensure the trustworthiness of financial data.
And now, understanding accounting principles before implementing accounting processes in a business is essential. It will help keep a smooth track of finances and maintain transparency of financial events. If you need help understanding the accounting principles, contact AHG Chartered Accountants, the best-chartered accountants in Egypt.