What Are Accounting Principles: With Examples
Accounting principles are the fundamental guidelines and rules that govern financial accounting. They provide a framework for the preparation and presentation of financial statements, and ensure that the information reported is reliable, consistent, and comparable.
The following are some of the most widely recognized accounting principles:
The Accounting Equation: states that assets = liabilities + equity. This principle forms the foundation of double-entry accounting and ensures that the accounting records are in balance.
The Historical Cost Principle: states that assets and liabilities should be recorded at their original cost when acquired. This principle ensures that the financial statements reflect the true value of the assets and liabilities at the time of acquisition.
The Revenue Recognition Principle: states that revenue should be recognized when earned, regardless of when payment is received. This principle ensures that revenue is reported in the period in which it is earned, rather than when payment is received.
The Matching Principle: states that expenses should be matched with the revenue they helped generate. This principle ensures that the financial statements accurately reflect the relationship between expenses and revenue.
The Conservatism Principle: states that accountants should choose the accounting method that yields the lowest net income. This principle ensures that the financial statements are not overstated and that any potential losses are recognized early.
The Materiality Principle: states that information should be considered material if its inclusion or exclusion would change or influence the decisions of an informed user of the financial statements.
The Full Disclosure Principle: states that all relevant information that could influence an informed user's understanding of the financial statements should be disclosed.
These are just some of the many accounting principles that govern financial accounting.
For example:
The historical cost principle ensures that assets and liabilities are recorded at their original cost when acquired. This means that when a company buys a piece of equipment for $10,000, it will be recorded as an asset on the company's balance sheet at $10,000, regardless of any changes in the equipment's value over time.
The revenue recognition principle ensures that revenue is recognized when earned, regardless of when payment is received. For example, if a company delivers goods to a customer on credit and the customer has not yet paid, the company will recognize the revenue when the goods are delivered, rather than waiting for payment.
The matching principle ensures that expenses are matched with the revenue they helped generate. For example, if a company incurs expenses in the production of goods, it will match these expenses with the revenue generated from the sale of those goods, rather than recognizing all expenses in the same period.
The conservatism principle ensures that the financial statements are not overstated and that any potential losses are recognized early. For example, if a company has a contract to provide services to a customer, but there is a risk that the customer may not pay, the company will record the revenue only when the payment is received, rather than recognizing it upfront.
Overall, these principles provide a framework for the preparation and presentation of financial statements and ensure that the information reported is reliable, consistent, and comparable.