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Accounting Principles

The document outlines key accounting principles, including the cost principle, accrual accounting principle, matching principle, and full disclosure principle, which are essential for consistent and reliable financial reporting. These principles ensure transparency, credibility, and informed decision-making for stakeholders while being relevant globally. Additional principles such as consistency, prudency, monetary unit, and going concern are also discussed, emphasizing their importance in maintaining accurate financial records.

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2 views

Accounting Principles

The document outlines key accounting principles, including the cost principle, accrual accounting principle, matching principle, and full disclosure principle, which are essential for consistent and reliable financial reporting. These principles ensure transparency, credibility, and informed decision-making for stakeholders while being relevant globally. Additional principles such as consistency, prudency, monetary unit, and going concern are also discussed, emphasizing their importance in maintaining accurate financial records.

Uploaded by

uymaxx3
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Accounting Principles

Find below explanations on the main accounting principles. There are a lot
of basic accounting principles, however the most important are the following
four:

 cost principle
 accrual accounting principle
 matching principle
 full disclosure principle
Accounting Principles

Definition:

 Accounting principles are standardized rules and guidelines for


recording, classifying, and reporting financial transactions.

Purpose:
 They ensure consistency, reliability, and comparability in financial
statements across companies and time periods.

Importance:

 Transparency: Provide clear and accurate financial


information to stakeholders.

 Credibility: Ensure that businesses maintain trust and


integrity in their financial reporting.

 Informed Decision-Making: Help investors,


creditors, and other users of financial statements make
better decisions based on reliable data.

Global Relevance:

 Accounting principles are used internationally, fostering


uniformity in global financial markets.

Cost Principle

➤ Essence: Assets are recorded at their original purchase price, ignoring


market changes.

The cost principle dictates that companies should record assets


based on their historical cost, meaning the amount that was paid during
acquisition, rather than reflecting their current market value. This principle
ensures objectivity and reliability in financial reporting because the purchase
price is a verifiable figure. While this method emphasizes consistency, it
doesn’t account for inflation or market value fluctuations, which can lead to
outdated financial information over time.
 Assets are valued at historical cost: For example, if a
company buys a piece of equipment for $50,000, it will continue
to list that equipment at $50,000 on its balance sheet, even if its
market value increases or decreases over time.
 Market fluctuations are not reflected in financial reports: If
that same piece of equipment is worth $60,000 today, the
financial statement will still report the original purchase price of
$50,000.

Benefit:
✅ The cost principle provides consistency and reliability in financial records
because it relies on factual, objective figures from actual transactions.

Issue:

🚫 It can result in outdated asset values, particularly for long-held assets,


which may no longer reflect their true worth in the market.

Accrual Accounting Principle


➤ Essence: Revenues and expenses are recognized when earned or
incurred, not when cash changes hands.

Accrual accounting focuses on recording revenues when they are


earned and expenses when they are incurred, regardless of when cash is
exchanged. This approach provides a more accurate picture of a company’s
financial performance by reflecting actual business activity rather than just
cash flow. For example, if a company delivers a service in December but
doesn’t get paid until January, the revenue is recorded in December because
that’s when it was earned.
 Revenue is recognized when earned, not when paid: For
instance, a company delivers a product to a client in November
but only receives payment in December. The revenue should still
be recorded in November when the product was delivered.
 Expenses are recognized when incurred, not when paid: If
the company incurs costs to manufacture a product in October
but pays the supplier in November, the expense is recognized in
October.

Benefit:
✅ Accrual accounting offers a more accurate financial performance overview
by aligning revenues and expenses with the period they are earned or
incurred.

Issue:

🚫 It can obscure a company’s actual cash position, complicating liquidity


management since the company may record profits without having the cash
on hand.
Matching Principle

➤ Essence: Expenses are recorded in the same period as the revenues they
help generate.

The matching principle states that companies should record


expenses in the same period in which the related revenues are earned. This
ensures that the financial statements accurately reflect the profitability of
the company. For example, if a business spends money on advertising in
December but earns the revenue from those ads in January, the expenses
should be recorded in January to match them with the corresponding
revenue.
 Costs are aligned with the revenues they support: For
instance, if a company spends $5,000 in December on advertising
for a product sold in January, the advertising expense should be
recorded in January to match the revenue earned from the
product sales.
 Ensures accurate profit measurement: This way, the
company’s reported profits reflect the true cost of generating the
revenue.

Benefit:
✅ The matching principle provides a clearer view of profitability by ensuring
that revenues and the expenses tied to them are reported together.

Issue:

🚫 It can be challenging to implement for long-term projects or contracts


where revenues and expenses occur over extended periods, making
accurate matching complex.

Full Disclosure Principle


➤ Essence: All relevant financial information must be clearly disclosed in
financial statements.

The full disclosure principle requires that all information that could
affect decision-making must be included in the financial statements. This
ensures that stakeholders—such as investors, creditors, or regulatory bodies
—have access to all relevant data that might impact their decisions. While
disclosure is important for transparency, it should also be balanced against
the costs and effort of preparing and providing the information.
 Key financial data must be disclosed for informed
decisions: If a company is involved in a lawsuit that could
significantly impact its financial position, this information should
be disclosed in the financial statements, even if the outcome is
uncertain.
 Balance between thoroughness and cost of disclosure is
essential: While it’s crucial to provide necessary information,
companies should avoid overloading users with irrelevant details
that make it hard to extract meaningful insights.

Benefit:
✅ The full disclosure principle promotes transparency, ensuring that
stakeholders have all the information they need to make informed decisions.

Issue:

🚫 Excessive disclosure can overwhelm users with too much information,


increasing the cost and complexity of financial reporting without necessarily
improving the usefulness of the data.
Apart from the main principles discussed above, here are additional also
important accounting principles:

Consistency Principle

 Once an accounting method is chosen, it should be used


consistently across periods.
This allows for better comparison of financial statements over
time and ensures reliability in reporting.

Prudency Principle

 In cases of uncertainty, expenses and liabilities should be


recorded as soon as possible, but revenue only when it’s assured.
 This leads to more cautious financial reporting, preventing
overstatement of assets or income.

Monetary Unit Principle

 Only transactions that can be measured in monetary terms are


recorded in the financial statements.
This simplifies financial reporting but ignores the effect of inflation
or qualitative aspects.

Going Concern Principle

 Financial statements are prepared under the assumption that the


business will continue operating for the foreseeable future.
 This affects how assets and liabilities are valued, as liquidation is
not expected.

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