Here we will cover the main accounting principles. There are a lot of basic accounting principles, however the most important part, are the following four:
- cost principle
- accrual accounting principle
- matching principle
- full disclosure principle
Further we will be covering in more details each of them.
I. Cost Principle. This principle is based on the assumption that all the assets are recorded in the accounting based on their historical cost. It is a cost which the business incurred while acquiring them. In their accounting records we are not paying attention to the market value of those assets, but the records are based on the historic data. This principle is prudent, since the expressed value of the assets is based on the historical cost. Market price or market value, which can fluctuate and also which can be based on some subjective aspects, is not taken into account. On the other hand it is also worth to mention that the information may be out dated and the financial statements might not present the fair value of the assets which were acquired quite a long time ago.
II. Accrual Accounting Principle. This principle is based on the assumption that we record and report revenue at that time when it is earned, but not when cash is received. If the business sells goods and pass the ownership title to the customer, sales revenue are recorded without waiting until the customer pays cash. Check also balance sheet example and template for better understanding of financial statements.
III. Matching Principle. This principle relates to the accounting for expenses and it states that we should recognize in the income statement only those expenses, which are related to revenue earned. Therefore if business incurs expenses related to the earned revenue, only then these expenses can be included into the Income Statement and deduct such expenses from revenue. However, if certain expenses were incurred and the revenue were not yet earned, it is not allowed to record such expenses and it is not allowed to deduct them from revenue. Matching principle is closely related to the accrual principle. Explore here income statement example and template for more knowledge about this financial statement.
IV. Full Disclosure Principle. This principle states that accounting records and financial statements must disclose the financial data, which is important for decision makers. Such financial data basically relates to those aspects, which are important and which may impact certain decisions. This is applicable to investors, creditors, employees, suppliers. And also it is important to remember that disclosure of such accounting information should not be due costly so if it is too expensive to disclose this information comparing to its usefulness so it is unreasonable to disclose such information so this is also important. If you are only minor items but it cost a lot to disclose them so we should not be disclosed in the financial statements and in the accounting records.
So these were full name accounting principles and we will be mentioning them during the whole course so please remember and understand them.
If you want to start learning financial analysis, check this ROA Formula – Return On Assets Formula to understand whether assets are being used efficiently.