Name # Muhammad Akbar

Assignment Name # Financial Accounting

What Are the Basic Principles of Accounting?

The basic principles of accounting are not just any arbitrary principles that differ from
accountant to accountant. Instead, the field of accounting is governed by a series of principles or
rules as defined by the Financial Accounting Standards Board (FASB).

These accounting principles are often referred to as GAAP (pronounced “gap”)—

meaning generally accepted accounting principles. On the whole, however, GAAP consists of
three parts:

1. The basic accounting principles and guidelines

2. The rules and standards issued by FASB
3. The generally accepted industry practices

PRINCIPAL OF ACCOUNTING
1. Economic Entity Assumption

In essence, the economic entity assumption principle is the accounting concept that states that a
business is an entity unto itself and should be treated as such. This principle is also sometimes
called the “separate entity assumption. “It is because of the economic entity assumption
principle, therefore, that your accountant would advise you to separate your business transactions
from your personal transactions—and the reason it’s so important to open a separate business
bank account. Even in the case of a sole proprietorship, where your business activity appears on
your personal tax return, the economic entity assumption still applies— because, legally, your
business can exist independently of you. So, not only does the economic entity assumption
protect your personal finances by insisting that they’re separate from your business finances, but
for sole proprietors, abiding by this basic accounting principle also makes the process easier if
you decide to incorporate in the future.

2. Monetary Unit Assumption

The monetary unit assumption principle dictates that all financial activity be recorded in the
same currency—which in the case of U.S. businesses, means in U.S. dollars. The monetary unit
assumption principle, therefore, is the reasoning behind why you have to go through the extra
effort to complete your business bookkeeping for foreign transactions.
Moreover, another assumption under this basic accounting principle is that the purchasing power
of currency remains static over time. In other words, inflation is not considered in the financial
reports of a business, even if that business has existed for decades.

3. Specific Time Period Assumption

The specific time period assumption requires that a business’s financial reports show results over
a distinct period of time in order for them to be meaningful to those reviewing them.
Additionally, this accounting principle specifies that all financial statements must indicate the
specific time period that they’re covering on the actual document.

It is because of this principle that your balance sheet always reports information as of a certain
date and your profit and loss statement encompasses a date range. Once again, all of your
financial statements—income statement, cash flow statement, statement of shareholders’ equity,
etc. must show the time period for the activity reported in order for you to be able to draw
insights from them.

4. Cost Principle

The cost principle dictates that the cost of an item doesn’t change in financial reporting.
Therefore, even if you’ve bought an item within a year that’s grown substantially in value—a
building, for example—your accountant will always report that asset at the amount for which it
was obtained. In other words, you’re always reporting the historical cost of the asset or item. 

This basic accounting principle is important because it reminds business owners not to confuse
cost with value. Although the value of items and assets changes over time, the gain or loss of
your assets is only reflected in their sale or in depreciation entries. If you need a true valuation of
your business without selling your assets, then you’ll need to work with an appraiser, as opposed
to relying on your financial statements.

5. Full Disclosure Principle

The full disclosure principle is a principle you may have heard in the news in regard to
businesses releasing information. Under this basic accounting principle, a business is required to
disclose all information that relates to the function of its financial statements in notes for the
reader that accompany the statements. Generally, these notes first list the business’s accounting
policies and follow with any additional relevant information.

This accounting principle helps ensure that stockholders, investors, and even the general public
are not misled by any aspect of a business’s financial reports.

6. Going Concern Principle

Also referred to as the “non-death principle,” the going concern principle assumes the business
will continue to exist and function with no defined end date—meaning the business will not
liquidate in the foreseeable future. It is because of this basic accounting principle, then, why you
defer the recognition of expenses to a later accounting period.

Moreover, this accounting principle also dictates that if an accountant thinks—based on a

business’s financial statements—that they’ll be forced to liquidate, they must disclose this
assessment.

7. Matching Principle

For tax purposes, many small businesses, especially sole proprietorships, choose to operate on a
cash basis—meaning revenue is reported when cash is received and expenses are reported when
cash is spent (or when your business’s credit card is charged). However, the matching principle
specifies that businesses should use the accrual method of accounting and report all financial
information using that method. 

Under this basic accounting principle, expenses should be matched with revenues and therefore,
sales and the expenses used to produce those sales are reported in the same accounting
period. These expenses can include wages, sales commissions, certain overhead costs, etc.

This being said, even if your tax return is based on the cash method of accounting, your
accountant may prepare your financial reports using the accrual basis of accounting. Ultimately,
accrual-based reports not only reflect the matching principle, but they also provide a better
analysis of your business’s performance and profitability than cash-based statements.

8. Revenue Recognition Principle

Like the matching principle, the revenue recognition principle relates to the accrual basis of
accounting. The revenue recognition principle dictates that revenue is reported when it’s earned,
regardless of when payment for the product or service is actually received. With this basic
accounting principle, therefore, your business could earn a monthly revenue even if you haven’t
received any actual cash that month.

The purpose of the revenue recognition principle, then, is to accurately report income, or
revenue, when the sale is made, even if you bill your customer or receive payment at a later time.

9. Materiality Principle

The materiality principle is one of two basic accounting principles that allows an accountant to
use their best judgment in recording a transaction or addressing an error.

To explain, the materiality principle may come into play when an accountant is reconciling a set
of books or completing a business tax return. If during this process the accountant finds that the
account is off by a relatively small amount in relation to the overall size of the business, they
may deem the discrepancy as immaterial. It’s up to the accountant to use their professional
judgment to determine if the amount is immaterial. 
This is all the more important because immaterial discrepancies can be disregarded, but material
discrepancies must be addressed—just as immaterial expenses can be recognized at the time of
purchase, but material expenses must be depreciated over time.

Ultimately, this principle highlights an accountant’s ability to exercise judgment and use their
professional opinion—since businesses come in all sizes, an amount that might be material for
one business may be immaterial for another—and it’s up to the accountant to make this
decision. 

Moreover, the materiality principle explains why your accountant might round the amounts on
your financial statements to the nearest dollar.

10. Principle of Conservatism

The principle of conservatism is the second principle that allows an accountant to use their best
judgment in particular situations. In this case, when there’s more than one acceptable way to
record a transaction, the principle of conservatism instructs the accountant to record expenses
and liabilities as soon as possible, but to only record revenues and gains when they occur. 

Using this accounting principle, then, your accountant will be more likely to anticipate losses in
your reports, but not revenues or profits—hence they’re being more conservative with the
business’s financial success.

It’s important to understand, however, that this basic accounting principle is only invoked when
there are multiple acceptable ways for the accountant to record the transaction. The principle of
conservatism does not allow a business accountant to completely disregard other accounting
principles

11. Revenue Recognition Principle

When you are recording information about your business, you need to consider the revenue
recognition principle. This is the period of time where revenues are recognized through the
income statement of your company. In order for your revenues to be recognized in the period
that the services were provided if you are on the accrual basis, If you are on the cash basis then,
the revenues need to be recognized in the period the cash was received.

12. Cost Principle

Cost principle: The cost of an item doesn’t change in financial reporting. Recording your assets when
you purchase a product or service helps keep your business’s expenses orderly. It’s important to
record the acquisition price of anything you spend money on and properly record depreciation
for those assets.
13. Objectivity Principle

The accounting data should consistently stay accurate and be free of personal opinions. Make
sure the data is also supported by evidence that can include vouchers, receipts, and invoices.
Having an objective viewpoint, in this case, helps rely on financial results. For example, your
viewpoint may not be objective if you once worked for the same company that you are now an
auditor for because your relationship with this client might skew your work.

Now that you’ve got all of these down, moving forward with the financial positioning of your
business will be effortless.

14.Reliability principle. This is the concept that only those transactions that can be proven should be
recorded. For example, a supplier invoice is solid evidence that an expense has been recorded. This
concept is of prime interest to auditors, who are constantly in search of the evidence supporting
transactions..

15.Consistency principle. This is the concept that, once you adopt an accounting principle or method,
you should continue to use it until a demonstrably better principle or method comes along. Not
following the consistency principle means that a business could continually jump between different
accounting treatments of its transactions that makes its long-term financial results extremely difficult to
discern.

16.Accrual principle.

This is the concept that accounting transactions should be recorded in the accounting periods when they
actually occur, rather than in the periods when there are cash flows associated with them. This is the
foundation of the accrual basis of accounting. It is important for the construction of financial statements
that show what actually happened in an accounting period, rather than being artificially delayed or
accelerated by the associated cash flows. For example, if you ignored the accrual principle, you would
record an expense only when you paid for it, which might incorporate a lengthy delay caused by the
payment terms for the associated supplier invoice.

17. Historical Cost

The Historical Cost principal states that business must record and account for the most assets and
liabilities at their purchase or acquisition price in other word business have to record an asset other
balance sheet for the amount paid for the asset. This Historical cost of an asset is completely reliable.
Historical cost is the original of an asset as recorded in an entity accouting records for example the
historical cost of a building was $10 M WHEN it was purchased 20 years ago but its current market value
is three times that figure;

18 Separate Entity

An accounting concept which treats a business from its owner. The Separate entity assumption states
that the transactions conducted by a business are separate to those conducted conduced by its owners.
This concept assumes that for accounting purpose the business enterprise and its owners are two
separate independent entites.Thus the business and personal transaction of its owner are separate.
FOR EXAMPLE. When the owner invests money in the business, it is reorded as liability of the business to
the owner. Similarly, when the owner takes away from the business cash/goods for his/her personal
use, it is not treated as business expense.

19.Single Entity

What is a single entity? A single entity is an operating unit for which financial information is reported. A
single entity may be a separate legal entity, a subsidiary, department or any other desigination as long
as information is collected specifically for it end decisions are made based on that information.The
separate entity concept states that we should always separately record the transaction of a business and
its owners. Otherwise , there is a considerable risk that the transactions of the two will become
intermingled. Single entity economic concept entity concept suggests that companies associated with
each other through the virtue of common control operate as single economic unit and therefore the
consolidated financial statements of a group of companies should reflect the essence of such
arrangements.