Accounting principles

5 Accounting Principles You Must Know

Accounting principles are a set of rules and guidelines that companies use to maintain accurate financial records.

These principles guide topics such as how to record transactions, when to recognize revenue, and how to value assets.

By adhering to these principles, businesses can ensure that their financial statements are accurate and transparent.

While there is no one universally accepted set of accounting principles, there are several widely used frameworks.

Such as Generally Accepted Accounting Principles (GAAP) in the United States and International Financial Reporting Standards (IFRS) globally.

By following these principles, businesses can provide investors and other stakeholders with clear insights into their financial health.

5 basic accounting principles

The most important accounting principles include the following: objectivity, conservatism, materiality, matching, full disclosure, and consistency.

Objectivity principle

The objective principle is one such Accounting principle that requires financial statements to provide a true and fair view of the enterprise’s financial position.

 Another name for the going concern principle is the true and fair view principle.  

Accounting statements prepared in conformity with this principle will not be misleading.

Materiality, another Accounting concept, determines which information must be in the financial statements and which is not.

This is because the inclusion of all information in the financial statements would make them very lengthy and difficult to understand.

So only those matters relevant and material, from the point of view of users of financial statements, are going to be in it. 

For example, information about repairs and maintenance expenditures incurred last year is not material and relevant from the point of view of users of this year’s financial statements.

Materiality principle

The materiality principle is one of the most important accounting principles.

It states that an accounting error is only material if it would affect the decision of a reasonable person.

In other words, if an error would not affect the result of a decision, it is not material.

It is important to follow the materiality principle in order to avoid magnifying accounting errors and to avoid wasting resources on correcting immaterial errors.

The application of the materiality principle can be complex, but it is essential to ensure the accuracy of financial statements.

Matching principle

The matching principle is one of the most important accounting principles.

It requires that expenses be matched with revenues in the period in which they are incurred.

This ensures that financial statements provide a true and accurate picture of a company’s financial health.

Without the matching principle, businesses could artificially inflate their profits by delaying expenses into future periods.

The matching principle is essential for creating accurate financial statements and for making sound business decisions.

Full disclosure principle

The full disclosure principle is one of the most important accounting principles.

It requires to disclose all information so it won’t impact a company’s financial statements.

This includes both positive and negative information.

The goal of the full disclosure principle is to ensure that investors have all of the information they need to make informed decisions about a company.

While it may seem like disclosing negative information could hurt a company, it is the opposite.

Investors need to know about both the good and the bad to make informed decisions.

Disclosing all information also helps to build trust between a company and its investors.

Consistency principle

The consistency principle is one of the most important accounting principles.

It states that once an accounting policy has been adopted, it should be consistently applied in future periods.

This principle is important because it helps to ensure the comparability of financial statements from one period to another.

If a company were to switch Accounting policies frequently, it would be difficult to compare its financial performance from one year to the next.

The consistency principle is also important because it helps to ensure the reliability of financial statements.

Preparing financial statements consistently guarantees it be accurate and trustworthy. 

Generally accepted accounting principles (GAAP)

Accounting principles are a set of rules and guidelines that companies use to record and report their financial activity.

Generally accepted accounting principles are a set of specific Accounting principles.

They were developed by the Accounting profession and have been accepted by the Securities and Exchange Commission.

Companies use Generally accepted accounting principles to ensure that their financial statements are reliable, transparent, and comparable with those of other companies.

Generally accepted accounting principles are constantly evolving as the Accounting profession works to keep up with changing business practices and regulatory requirements.

However, the core Accounting principles of GAAP remain relatively stable.

As a result, companies can rely on GAAP to provide a consistent framework for their financial reports.

Non-GAAP reporting

GAAP is the acronym for generally accepted accounting principles.

These are the rules that govern reporting financial data.

Non-GAAP reporting is a type of accounting that does not follow these rules.

Instead, it uses its own set of standards.

Companies use non-GAAP reporting to give a more favorable picture of their financial situation.

For example, a company might exclude certain expenses from its non-GAAP report to make its profits look higher.

Non-GAAP reports are not necessarily wrong or misleading, but they can be confusing for investors and make it difficult to compare companies.

Limitations of GAAP

While GAAP is the standard set of guidelines for publically traded companies in the US, there are some limitations to be aware of.

First, GAAP only applies to accounting periods ending on or after December 15, 2018 – so if you’re looking at an older financial report, it may not be GAAP compliant.

In addition, GAAP only applies for the foreseeable future, so if a company is facing significant uncertainty, it may not be able to rely on GAAP.

In addition, while GAAP provides consistency, there is still room for interpretation, so different companies might report similar items in different ways.

Despite these limitations, GAAP is still the best source of information for understanding a company’s financials.

International Financial Reporting Standards (IFRS)

Financial statements are the language of business and their use is to communicate financial information about a company.

The goal of financial reporting is to provide financial information that is useful to users in making economic decisions.

Users of financial statements include present and potential investors, creditors, and every person who has an interest in the financial affairs of a company.

The Financial Accounting Standards Board (FASB) is the organization responsible for setting accounting standards in the United States.

Designed to provide a common global language

International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB).

IFRS is designed to provide a common global language for business affairs so that companies can make informed economic decisions.

There are several benefits to adopting IFRS.

First, it would allow companies to prepare financial statements using a common set of standards.

This would make it easier for investors and other users of financial statements to compare financial data across companies.

Second, it would improve the comparability of financial statements between countries.

This would make it easier for investors to compare investment opportunities on a global basis.

Finally, it would reduce the cost of compliance with different accounting standards by providing a single set of high-quality standards that companies could use.

Limitations of IFRS

While IFRS provides a common framework for financial reports, there are some limitations to consider.

First, IFRS is only applicable to public companies.

Private companies may choose to use IFRS, but they have to do so.

Second, IFRS only apply to the accounting period in which they are issued.

This means that companies must keep up-to-date on the latest changes to ensure compliance.

Finally, companies must maintain accurate accounting records to comply with IFRS.

This can be a challenge for small businesses that do not have dedicated accounting staff.

Overall, while IFRS provides a helpful framework for financial reporting, there are some limitations to consider.

How does IFRS differ from GAAP?

If you work in financial accounting, you should know the difference between IFRS and GAAP.

The Financial Accounting Standards Board promulgates General Accounting Principles (GAAP), a set of financial accounting standards.

IFRS, on the other hand, is the International Financial Reporting Standard.

While both are global finance report frameworks, there are some key differences between them.

GAAP is more rules-based

One of the biggest differences is that GAAP is more rules-based while IFRS is more principles-based.

 Accordingly, IFRS allows for more flexibility in reporting financial information.  

As a result, financial statements prepared under IFRS can sometimes be less detailed than those prepared under GAAP.

Additionally, IFRS allows for more flexibility when it comes to financial data presentation.

For example, companies can choose to present their financial information on a consolidated basis or as separate entities.

Understanding the difference between IFRS and GAAP is essential for anyone who works in financial accounting.

Knowing which framework to use will ensure that financial statements are accurate and compliant with applicable regulations.

The governmental accounting standards board

The Governmental Accounting Standards Board (GASB) is the independent, not-for-profit organization that creates and maintains generally accepted accounting principles (GAAP) for state and local governments in the United States.

GASB was founded in 1984 in response to the need for improved finance reports by state and local governments.

Before GASB’s formation, there was no single, uniform set of accounting standards for public entities.

As a result, financial statements could vary widely from one government to the next, making it difficult to compare apples to apples.

GASB works on improving financial reporting

Today, GASB continues to work on improving finance reports by state and local governments.

In addition to issuing new accounting standards, the GASB also guides their implementation.  

Finally, GASB conducts outreach to ensure that stakeholders understand and can comply with GAAP.

Who sets accounting principles and standards?

The international accounting standards board is responsible for setting accounting principles and standards.

Revenue recognition principle

This principle is an accounting guideline that requires companies to record revenue when it is earned, rather than when it is received.

This means that revenue should be recognized when the product or service has been delivered and the customer is satisfied with the results.

Some cases may require recognizing revenue before receipt of payment.

Because of this principle, companies are only able to record the revenue that they earn.

This prevents them from artificially inflating their earnings by including payments that have not yet been made.

As a result, the revenue recognition principle helps to provide accurate financial information for both investors and creditors.

Without this principle, companies could report their revenues prematurely, which would give investors a false impression of the company’s financial health.

The international accounting standards board is constantly working to improve and update accounting standards, to ensure that companies are reporting their financial information accurately and transparently.

Jordan Salas
Jordan Salas

Jordan is an experienced CPA and an author & editor at Financopedia. Over the past 12 years, he has written tax and financial content for leading brands. His writing has been featured in Forbes, The Los Angeles Times, Walstreet journal, and more. Jordan enjoys watching old movies and hiking in his free time.

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