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Accounting Principles & Concepts-Basic 4
Accounting Principles & Concepts-Basic 4
Accounting principles are essential rules and concepts that govern the field of
accounting, and guides the accounting process should record, analyze, verify and
report the financial position of the business.
These principles are used in every step of the accounting process for the proper
representation of the financial position of the business. These are explained below:
Further to illustrate, assume that on July 25 a Radio Station contracts with a Car
Dealership to air a series of one-minute advertisements during August. If all of the
agreed-upon ads are aired in August, but payment for the ads is not received until
September, in which month should the station recognize the advertising revenue?
The answer is August, the month in which it rendered the services that earned the
advertising revenue
2. Matching Principle:
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recognized on all goods sold during a period, the cost of those goods sold should also
be charged to that period. It is wrong to recognize revenue on all sales, but charge
expenses only on such sales as are collected in cash till that period. This concept is
basically an accrual concept since it disregards the timing and the amount of actual
cash inflow or cash outflow and concentrates on the occurrence (i.e. accrual) of
revenue and expenses. This concept calls for an adjustment to be made in respect of
prepaid expenses, outstanding expenses, accrued revenue, and unearned revenues.
Matching does not mean that expenses must be identifiable with revenues. Expenses
charged to a period may or may not be related to the revenue recognized in that
period, e.g. cost of goods sold and commission to salesmen are directly related to
sales whereas rent, interest, depreciation accruing with the passage of time and
stock lost by fire are not directly related to sales revenue yet, they are charged to the
accounting period to which they relate.
Assume that the Salaries earned by A Company’s Marketing Team for serving
customers in July are not paid until early August. In which month should these
Salaries be regarded as Expenses—July or August? The Answer is July, because
July is the Month in which the Marketing Team’s Services helped to generate
Revenue. Just as Revenue and Cash Receipts are not one & the same, Expenses &
Cash Payments are not identical.
In fact, the Cash Payment of an Expense may occur before, after, or in the same
period that Revenue is earned. In deciding when to report an Expense in the Income
Statement, the Critical Question is, “In what period does the expense help to
produce revenue?”— Not, “When does the payment of cash occur?
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subsequent accounting periods. Accordingly, if nothing is paid to acquire an asset;
the same will not be usually recorded as an asset, e.g. a favorable location, and
increasing reputation of the concern will remain unrecorded though these are
valuable assets.
Example: A business purchased a piece of land for $70,000 ten years ago. Even
though the land can be now sold for more than this, it is not revalued in the financial
statements. It remains recorded at $70,000.
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4. Business Entity Principle/Concept:
If the owners were to commingle their personal activities with the transactions of
the business, the resulting financial statements would fail to describe clearly the
financial activities of the business organization. Distinguishing business from
personal activities of the owners may require judgment by the accountant
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