Regardless of business size, accounting and basic accounting principles are a crucial part of the business and have remained so from time immemorial. Modern times have resulted in the inclusion of the latest technologies. Therefore, accounting software has become a necessity for businesses to do their daily accounting. The tracking and recording of a business’s financial transactions through efficient accounting help evaluate an organisation's financial performance. Both external and internal stakeholders, banks, regulators, tax authorities and other institutions use these business financial statements to assess the organisation’s health and credit facilities.
What is accounting principle?
The standard guidelines or rules used in accounting are recording and tracking a business’s financial transactions and drawing up the financial statements from records. These are called accounting principles. They form the base guidelines used in preparing and recording a firm’s financial statements and are also called the Generally Accepted Accounting Principles (GAAP).
The accounting principles and concepts have global acceptance and bring an acceptable format and accounting uniformity when preparing financial statements. The authorities and regulators in each country, like India, USA, UK, etc., have different GAAP procedures in accounting. However, the objectives, fundamentals and core accounting principles of all GAAP procedures are identical.
Need for accounting principles
Consider the possibility of every business having its principles of accounting and preparing its financial statements. Thousands of different formats in financial statements would be present for the same financial information. Businesses themselves will find it hard to evaluate their performance, compare their competitor’s financial statements or approach each other for raising funds, supplying goods, etc. Financial data and statements would be useless in evaluating businesses, as there would be no common format or principle followed when preparing the financial statements. That’s why accounting principles are needed to provide a form of standardisation and uniform reporting of financial statements and accounting practices.
The importance of accounting principles
The Generally Accepted Accounting Principles (GAAP) ensure that financial statements are accurate and consistent in recording and tracking financial records uniformly and globally. They set up certain protocols, accounting concepts and standards, that all businesses and companies should and are expected to follow when accounting. This helps get efficient reports and accurate financial statements when viewing an organisation’s reports or statements like the Balance Sheet or Profit and Loss Statements.
Accounting principles preconditions
The body of doctrines or accounting principles is associated with the theory of the accounting method. This justifies the financial reporting and its current practices. You and your accountant may choose one method of accounting while your vendors and clients may use some other form of accounting. The applied basic accounting principles should help in maintaining uniformity in reporting, recording, and tracking financial transactions. There are certain preconditions to be met by accounting principles such as:
- Accounting principles must be based on realistic assumptions.
- An explanatory, simple and understanding principle should underlie the practice.
- They must be used throughout and consistently.
- Future predictions should be possible to derive from such accounting principles.
- They must be uniform and informative across all its users.
Also Read: Profit and Loss Account & Statement
To understand the types of accounting principles, you must first understand the accounting conventions and the accounting concepts that form the accounting principles involved in business accounting. So, let’s begin with the concepts and conventions that overlap in accounting practices, including the popular accounting principles.
Some of the important accounting concepts and conventions underpinning the principles of accounting are discussed below:
- The concept of money measurement:
Business transactions in accounting use money as a measure and unifying factor in accounting measurements. This accounting principle makes perfect sense once you accept money as the common measurement unit in recording financial transactions. The accounting principles for money used in financial transactions are that only events and transactions involving money are recorded as accounting transactions and show the amount or value of money in the transaction in its recording.
- The concept of a business entity:
This accounting concept says your business identity is independent of your identity. The accounting principle views the business owner and the business as separate entities that are distinctly separate as far as financial transactions and accounting are concerned. Thus, legally, the business from your name can be sued, or your business can be sued independently.
- The concept of an ongoing enterprise:
This concept states that the enterprise’s financial transactions are assumed to be tracked and recorded based on the presumption that it will continue to remain in operation independently and for a very long time besides fulfilling its obligations as per its commitments.
- The concept of cost:
This concept defines and sets the rules to account for an organisation’s fixed assets. The cost concept states that an organisation’s fixed assets must always be accounted for at the item’s original price and its value depreciated on an annual basis. This is based on wear and tear, asset usage, accidents that may occur, and the time elapsed since the asset was bought, among other factors.
- The concept of duality:
This concept of duality states that for every credit transaction of a specific amount, a corresponding debit transaction for the same amount must also be made in accounting practices. This premise is used as the foundational principle in a double-entry accounting system.
- The concept of accounting year:
This concept or accounting principle states that each business is free to choose a specific period to start and finish its accounting reporting cycle, which must be mentioned in its reporting. This is called the accounting periodicity and could be weekly, quarterly, monthly, half-yearly or annually.
- The concept of matching expenses:
This interesting concept stresses that if any revenue is recorded and recognised in accounting, then the expenses incurred related to it in earning the revenue are also accounted for and recognised. This is done to give an accurate value of the profit earned in the specified accounting period.
- The concept of realisation of dues:
This concept in accounting states that whenever a revenue transaction is reported or accounted for, it is considered revenue earned, immaterial of when its payment is finally received. However, all things received or paid for are not considered a profit transaction until the services or goods so bought are delivered to the buyer.
What are the accounting principles conventions used?
Having understood the concepts in accounting, it is necessary to understand the accounting conventions used in accounting principles. An accounting convention means a set of traditions, practices and customs that guide the firm in its preparations when readying its accounting statements. The accounting conventions are a result of derived practice and usage.
There are four critical conventions to follow in accounting principles and reporting:
- Convention on Consistency: Accounting consistency is a basic assumption made when accounting states that all policies and practices are followed. In contrast, accounting is consistent over any period and from one period to another.
- Convention of full disclosure: This is an important part of accounting practice and states that accounting should be conducted and prepared openly and transparently. All material information on transactions is clearly and fully disclosed.
- Convention regarding conservatism: This convention implies that all prospective losses have already happened, and all prospective profits are not accounted for until they are thoroughly and finally earned.
- Convention on materiality: In the principle of materiality, the financial reports and statements should contain all items that have an economic effect on a business's accounting. They should be fully disclosed in its financial reports and statements. The unimportant items may be merged with other items or ignored completely when the value and impact are very small.
International Financial Reporting Standards (IFRS)
The primary aim of a principle of accounting is to maintain, track, record and keep systematic accounting records. From the financial status, the value and performance of a business entity can be accurately and quickly drawn up and communicated to the required person. The financial statements in accounting form the basis of information relied upon in the management of a firm that makes a public communication of its financial information with quantitative details. Accounting software like the Biz Analyst app and Khatabook make such quantitative details easily available and maintained while following all Accounting Principles as required by statutory bodies.
The International Financial Reporting Standards (IFRS) are accounting principles, and common rules set globally to ensure transparency, consistency, comparability in financial reports and statements. The primary objective of the IFRS is to clearly state how organisations must report, maintain and account for the various defined transaction types or events that have a significant financial impact on the business.
Differences between the GAAP and IFRS
There are certain differences between GAAP and the IFRS, which are tabulated below:
IFRS is the global accounting system used by 110 countries like the EU, South American and Asian countries.
GAAP is the standard accounting system adopted by the USA or United States of America solely.
The system is accounting principles-based.
The system is accounting rules-based.
This accounting system allows the below assets to be revalued according to their fair value, which can be more reliably measured. The assets are property, inventories, investments in securities, intangible assets and plant & equipment.
The revaluation of an asset is not allowed, except for marketable securities.
It allows the reversal of impairment losses for all asset types except goodwill.
It prohibits impairment losses reversal for all asset types.
Long-term assets are cost valued initially and can then be revalued to the prevailing market price.
Assets such as furniture, buildings, equipment etc., are historic cost valued and depreciated suitably.
Also Read: All You Need To Know About Cash Deposit Slip
The principle of accounting follows standard account principles to bring about uniformity and standardisation in the accounting of financial transactions and the reporting in financial statements. It is crucial to quickly arrive at a Trial Balance Sheet, Balance Sheet and Profit and Loss Account statement without hassles. Modern-day accounting software makes this an easy task by accepting and reporting the fundamental account principle based on its accounting principles, concepts and conventions. Did you know that the Khatabook app can not only record your transactions and accounting accurately and quickly but also provide you with your financial statements using just your mobile phone? If you need accounting software on your phone, try it today!