The principles of accounting are the guidelines that businesses follow when preparing their accounting books and records.
Luckily accounting has become standardized so by following the principles of accounting, users of the financial statements are able to have comparability between financial statements.
We’ll look at the principles of accounting, explain them and by the end, you should be familiar with all of the basic principles.
What Are the Principles of Accounting?
So many sources are all over the place. 3 principles of accounting, 4,5,6,10. The numbers are all over the place. We are concerned with 4 main principles of accounting and will highlight two other major ones for a total of 6.
4 Principles of Accounting
#1 The Matching Principle:
Part of accrual accounting, the matching principle states that when a company recognizes revenue and records it, it should also record the costs and expenses related to the same transaction, in the same period.
The matching principle is key to double-entry bookkeeping and accrual accounting. For example, if a company sells a unit, it should record the income as sales but the expense as cost of goods sold.
#2 Revenue Recognition Principle:
Another key principle of accounting is the revenue recognition principle. The revenue recognition principle states that revenue should be recognized when a product or service is delivered.
Revenue is not recognized when cash is received. That would align with the cash basis of accounting.
#3 Cost Principle:
Formally known as the historical cost principle, the principle requires assets to be recorded as the cash amount an asset was acquired for, at the time of acquisition or the equivalent amount.
The holding value does not increase for improvements in value. If a van is bought for $33,000 then it would be recorded at a cost of $33,000 on the accounting books.
#4 Full Disclosure Principle:
One of the most important principles for users of financial statements is the full disclosure principle.
It says that businesses need to provide information so users of the financial statements can make informed decisions based on the disclosures in the notes of the financial statements.
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2 Additional Principles of Accounting
#5 Conservatism Principle
The concept behind the principle of conservatism is that liabilities and expenses should be recognized as soon as possible when there is uncertainty but uncertain gains should not be recorded until reasonably certain.
#6 Consistency Principle
The consistency principle says that businesses shouldn’t switch accounting policies during the period but rather be consistent so that users of the statements can make informed decisions from what is presented in the financial statements.
One Assumption to Know As Well – The Going Concern Assumption
Going concern in accounting says that a business has enough cash and resources to operate into the foreseeable future. Audit firms usually peg this as at least 12 months of resources on hand.
At the end of their audit cycles, the auditors confirm with management that the business has no going concern issues.
If there are going concern issues then the financial statements will disclose this as part of the full disclosure principle. They may state the business is looking to wind down or it will be going into a form of bankruptcy.
So What Do All These Principles of Accounting Fall Under? (Hint: GAAP)
The principles of accounting fall under Generally Accepted Accounting Principles (“GAAP”). GAAP is overseen by the Financial Accounting Standards Board (“FASB”).
GAAP is the accounting methodology adopted by publicly traded companies in the U.S. and most private businesses too!
When Do Principles of Accounting Need to Be Applied?
The principles of accounting should be applied anytime a company is looking to follow GAAP. Keep in mind that the cash basis of accounting will violate some of the 6 principles of accounting explained above.
So, do you need to apply all of those principles to confirm with GAAP? You bet. An accountant can help you with your books and records if you are a small business learning accounting but want to apply GAAP.
Otherwise, many small businesses are just fine using the cash basis of accounting.
Let’s Recap on the Principles of Accounting | Key Takeaways
There are a few things to remember about the principles of accounting:
- The four main principles of accounting include the matching principle, historical cost, revenue recognition and full disclosure principle.
- Two additional principles that are key are conservatism and consistency.
- Going concern is an assertion that the business can run into the foreseeable future.
- All principles, along with the going concern assertion must be applied to conform with GAAP.
Final Thoughts on the Principles of Accounting
Learning the principles of accounting is an essential beginner accounting step. You’ll get to a point where you have memorized these and can recite them out loud.
Until then, be sure to bookmark us, pop back during your studies and get your accounting right as you learn your accounting skills.
