Accounting principles are uniform practices which entities follow to record, prepare and present financial statements. An entity must prepare its financial statements as per acceptable accounting principles in order to present true and fair view of state of affairs of entity.
In India, general accounting principles are accounting standards and Indian Accounting Standards.
Uniform accounting principles assist in comparison of financial statement of entities. If accounting principles followed are same then reader of financial statements can compare financial results of two entities. However, if separate entities follow different accounting principles, they should at first prepare financials as per same accounting principles and then reader should make a comparison.
Benefits of accounting principles given in Accounting Standards or Indian Accounting Standards (Ind AS):
Accounting principles given in Accounting Standards (AS) and Indian Accounting Standards (Ind AS) are of great importance as it provides the basis for:
- Recognition of an item as income, expense, asset or liability
- At what amount it shall be recognised in the books of accounts and
- How to present these items in statement of P&L or Balance sheet
- It also provides what all disclosures are required to be made with respect to the items recognised.
Accounting principles guide entities on preparation and presentation of financial statements. It reduces the inconsistencies, presents true and fair view of state of affairs and makes comparison easier.
Examples of accounting principles
There are some of the main accounting principles and guidelines, listed under US GAAP:
Conservatism principle – In situations where there are two acceptable solutions for reporting an item, the accountant should ‘play it safe’ by choose the less favourable outcome. This concept allows accountants to anticipate future losses, rather than future gains.
Consistency principle – The consistency principle states that once you decide on an accounting method or principle to use in your business, you need to stick with and follow this method throughout your accounting periods.
Cost principle – A business should record their assets, liabilities and equity at the original cost at which they were bought or sold. The real value may change over time (e.g. depreciation of assets/inflation) but this is not reflected for reporting purposes.
Economic entity principle – The transactions of a business should be kept and treated separately to that of its owners and other businesses.
Full disclosure principle – Any important information that may impact the reader’s understanding of a business’s financial statements should be disclosed or included alongside to the statement.
Going concern principle – The concept that assumes a business will continue to exist and operate in the foreseeable future, and not liquidate. This allows a business to defer some prepaid expenses (accrued) to future accounting periods, rather than recognise them all at once.
Matching principle – The concept that each revenue recorded should be matched and recorded with all the related expenses, at the same time. Specifically in accrual accounting, the matching principle states that for every debit there should be a credit (and vice versa).
Materiality principle – An item is considered ‘material’ if it would affect or influence the decision of a reasonable individual reading the company’s financial statements. This concept states that accountants must be sure to include and report all material items in the financial statement.
Monetary unit principle – Businesses should only record transactions that can be expressed in terms of a stable unit of currency.
Reliability principle – The reliability principle is used as a guideline in determining which financial information should be presented in the accounts of a business.
Revenue recognition principle – Companies should record their revenues when it is recognised, or in the same time period of when it was accrued (rather than when it was received).
Time period principle – A business should report their financial statements (income statement/balance sheet) appropriate to a specific time period.