ACT1101 LECTURE NOTES#002

1st Semester 2020-2021 ACCOUNTING PRINCIPLES

13 Essential Accounting Principles

1. Accrual principle
2. Conservatism principle
3. Consistency principle
4. Cost principle
5. Economic entity principle
6. Full disclosure principle
7. Going concern principle
8. Matching principle
9. Materiality principle
10. Monetary unit principle
11. Reliability principle
12. Revenue recognition principle
13. Time period principle

To grasp the fundamentals of such a complex field, we compiled this list of 13 essential accounting
principles. These principles break down the general rules of accounting into individual parts that
demonstrate the fundamentals on which the financial accounting world is based.

13 accounting principles that are essential to financial accounting

These 13  principles form the backbone of financial accounting. Let’s dive in to take a look at what
these principles are and how they affect the work of accountants:

Accrual principle
The foundation for accrual basis accounting, the accrual principle states that transactions should be
recorded in the period in which they occur. This principle is in contrast to the idea that transactions
should be recorded in the period in which cash flows as a result of the transaction’s occurrence. A
demonstration of the accrual principle would be recording revenue when a customer is invoiced
instead of when the customer pays.

Conservatism principle
The conservatism principle of accounting helps accountants decide between two seemingly equally
acceptable options when reporting an item. In practice, the conservatism principle implies that an
accountant should recognize the transaction resulting in the lowest amount of net profit when given a
choice of transactions with equally likely outcomes. At the center of the conservatism principle is the
fundamental that revenue and assets should be recognized only when they are sure of being received

Consistency principle
The consistency principle outlines that accountants should maintain the same accounting method
across transactions and over a long period of time. If a business uses different accounting methods
and practices, it can skew the reporting so that long-term results are difficult to interpret.

Cost principle

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ACT1101 LECTURE NOTES#002
1st Semester 2020-2021 ACCOUNTING PRINCIPLES

The cost principle asserts that a business should record its assets, liabilities, and equity investments at
their original purchase costs rather than what they’re currently valued at. However, this principle is
not widely used. Recent trends in accounting have popularized the practice of recording these items
at their fair values instead of their original purchase prices.

Economic entity principle

The economic entity principle states that a business’s transactions should be kept separate from
those of the owner, partners, and shareholders of the company. All transactions under this principle
must be assigned to a specific entity of the business, and cannot be mixed with other entities.

Full disclosure principle

The full disclosure principle demands that businesses report all necessary information about their
financials to all parties that are inclined to read this information. This principle ensures that all
viewers of a company’s financial information are not misled or left out of having access to important
information.

Going concern principle

The going concern principle is the assumption that an entity will remain in business for the long-term
future. While seemingly intuitive, this principle assures readers of financial information that a
company will not be folding operations or liquidating its assets in the short term. Therefore, an
accountant can be justified in holding off on recognizing certain expenses until a later period, when
the company will still be in business.

Matching principle
The matching principle mandates that a business should report an expense on its income statement in
the same period in which the revenue is earned. If this expense is not directly tied to revenues, then it
should be reported on the income statement in the period in which it expires. 

Materiality principle
The materiality principle guides accountants to ignore the accounting standard if the net impact of
ignoring this standard is so small that it does not mislead readers regarding any financial information.
There are no set guidelines for what constitutes a small net impact, as even if a minor item
constitutes 1% of total assets, it still has the potential ability to change a net profit to a net loss. In
using the materiality principle, it’s best to exercise personal judgment on a case-by-case basis to
determine when its use is appropriate.

Monetary unit principle

The monetary unit principle states that businesses should only record transactions that can be
presented in terms of a unit of currency. An asset that is purchased for a specific price falls under this
category. This principle guides a business to avoid estimating its value of assets and liabilities.

Reliability principle

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ACT1101 LECTURE NOTES#002
1st Semester 2020-2021 ACCOUNTING PRINCIPLES

The reliability principle is the base assumption for all financial statements that all financial
information presented is the most accurate and relevant information available. In order for financial
information to be of use to accountants and shareholders alike, it needs to be useful or important for
decision-making regarding a company’s financial health.

Revenue recognition principle

The revenue recognition principle states that revenue should only be recorded when it is earned, not
when cash is collected. For example, if a furniture business agrees to sell a table to a customer and
provides the customer with the table, it can recognize the revenue can be recorded right then even if
the customer does not pay for the table until a week later. 

Time period principle

The time period principle outlines that a business should report all of its financial results from its
activities over a standard time period. A standard time period is typically monthly. quarterly, or
annually. Any financial statement includes in its header the time period covered by the statement to
note that this principle is acknowledged.