Republic of the Philippines

BOHOL ISLAND STATE UNIVERSITY

Clarin Campus
Poblacion Norte, Clarin, Bohol

Name: Christian D. Padilla

Subject: Financial Management in Education
Professor: Dr. Roxanne P. Altea
Basic Principles of Accounting
Accounting is a system meant for measuring business activities, processing of
information into reports and making the findings available to decision-makers. The
documents, which communicate these findings about the performance of an
organisation in monetary terms, are called financial statements. Usually, accounting is
understood as the Language of Business. However, a business may have a lot of
aspects which may not be of financial nature. As such, a better way to understand
accounting could be to call it The Language of Financial Decisions. The better the
understanding of the language, the better is the management of financial aspects of
living.
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 or Generally
Accepted Accounting Principles. These accounting principles guarantee consistency in
accounting reports and financial statements among all businesses and therefore, help
protect business owners, consumers, and investors from fraud. Ultimately, then, the
more you understand about these basic accounting principles, the easier it will be to
work with any accounting professional for business.
Although there are numerous principles and guidelines that make up GAAP as
defined by the FASB, we can condense them into the list of basic accounting principles
that are some of the most commonly used in the industry and therefore, some of the
most important to understand.
The first accounting principle to be discussed is the “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.
The second one will be the “Monetary Unit Assumption Principle”. 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.
The third one will be the “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.
The fourth one will be “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 like 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.
The fifth one will be the “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.
The sixth one will be the “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.
The seventh one will be the “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, this 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.
The eighth one from the list will be the “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.
Another principle will be the “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.
Lastly, will be the “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.
In conclusion, the field of accounting is vast and complex but, by understanding
the fore mentioned basic accounting principles you’ll have better insight into a core
piece of your business’s financial processes whether or not you outsource these
processes to a professional. However, not every business is required by law to comply
with GAAP, but most accountants will insist on following these principles to ensure
there’s never a question about the integrity of business’s financial statements.