Accounting Principles

Accounting principles
Accounting Principles
What are Accounting Principles?
Definition: Accounting principles are the building blocks for GAAP. All of the concepts and
standards in GAAP can be traced back to the underlying accounting principles. Some accounting
principles come from long-used accounting practices where as others come from ruling making
bodies like the FASB.
It’s important to have a basic understanding of these main accounting principles as you learn
accounting. This isn’t just memorizing some accounting information for a test and then
forgetting it two days later. These principles show up all over the place in the study of
accounting. Trust me. After you know the basic accounting principles, most accounting topics
will make more sense. You will be able to reference these principles and reason your way
through revenue, expense, and any other combination of problems later on in the study course.
List of 10 Basic Accounting Principles

Here’s a list of more than 5 basic accounting principles that make up GAAP in the United
States. I wrote a short description for each as well as an explanation on how they relate to
financial accounting.
 Historical Cost Principle
 Revenue Recognition Principle
 Matching Principle
 Full Disclosure Principle
 Cost Benefit Principle
 Conservatism Principle
 Consistency Principle
 Objectivity Principle
 Accrual Principle
 Economic Entity Principle
Historical Cost Principle

Historical Cost Principle – requires companies to record the purchase of goods, services, or
capital assets at the price they paid for them. Assets are then remain on the balance sheet at their
historical without being adjusted for fluctuations in market value.
Revenue Recognition Principle
Revenue Recognition Principle – requires companies to record revenue when it is earned instead
of when it is collected. This accrual basis of accounting gives a more accurate picture of
financial events during the period.
Matching Principle
Matching Principle – states that all expenses must be matched and recorded with their respective
revenues in the period that they were incurred instead of when they are paid. This principle
works with the revenue recognition principle ensuring all revenue and expenses are recorded on
the accrual basis.
Full Disclosure Principle

Full Disclosure Principle – requires that any knowledge that would materially affect a financial
statement user’s decision about the company must be disclosed in the footnotes of the financial
statements. This prevents companies from hiding material facts about accounting practices or
known contingencies in the future.
Cost Benefit Principle

Cost Benefit Principle – limits the required amount of research and time to record or report
financial information if the cost outweighs the benefit. Thus, if recording an immaterial event
would cost the company a material amount of money, it should be forgone.
Conservatism Principle
Conservatism Principle – accountants should always error on the most conservative side possible
in any situation. This prevents accountants from over estimating future revenues and
underestimated future expenses that could mislead financial statement users.
Objectivity Principle
Objectivity Principle – financial statements, accounting records, and financial information as a
whole should be independent and free from bias. The financial statements are meant to convey
the financial position of the company and not to persuade end users to take certain actions.
Consistency Principle
Consistency Principle – all accounting principles and assumptions should be applied consistently
from one period to the next. This ensures that financial statements are comparable between
periods and throughout the company’s history.
List of Key Accounting Assumptions

Here is a list of the key accounting assumptions that make up generally accepted accounting
principles:
 Monetary Unit Assumption
 Periodicity Assumption
Monetary Unit Assumption

Monetary Unit Assumption – assumes that all financial transactions are recorded in a stable
currency. This is essential for the usefulness of a financial report. Companies that record their
financial activities in currencies experiencing hyper-inflation will distort the true financial
picture of the company.
Periodicity Assumption
Periodicity Assumption – simply states that companies should be able to record their financial
activities during a certain period of time. The standard time periods usually include a full year or
quarter year.
Fundamental Accounting Concepts and Constraints

Here is a list of the four basic accounting concepts and constraints that make up the GAAP
framework in the US.
 Business Entity Concept
 Going Concern Concept
 Materiality Concept
 Industry Practices Constraint
Business Entity Concept

Business Entity Concept – is the idea that the business and the owner of the business are separate
entities and should be accounted for separately. This concept also applies to different businesses.
Each business should account for its own transactions separately.
Going Concern Concept

Going Concern Concept – states that companies need to be treated as if they are going to
continue to exist. This means that we must assume the company isn’t going to be dissolved or
declare bankruptcy unless we have evidence to the contrary. Thus, we should assume that there
will be another accounting period in the future.
Materiality Concept
Materiality Concept – anything that would change a financial statement user’s mind or decision
about the company should be recorded or noted in the financial statements. If a business event
occurred that is so insignificant that an investor or creditor wouldn’t care about it, the event need
not be recorded.
Industry Practices Constraint

Industry Practices Constraint – some industries have unique aspects about their business
operation that don’t conform to traditional accounting standards. Thus, companies in these
industries are allowed to depart from GAAP for specific business events or transactions.
Why Are Accounting Principles Important?

Generally Accepted Accounting Principles are important because they set the rules for reporting
and bookkeeping. These rules, often called the GAAP framework, maintain consistency in
financial reporting from company to company across all industries.
Remember, the entire point of financial accounting is to provide useful information to financial
statement users. If everyone reported their financial information differently, it would be difficult
to compare companies. Accounting principles set the rules for reporting financial information, so
all companies can be compared uniformly.
What is the Purpose of Accounting Principles?
The purpose of accounting principles is to establish the framework for how financial accounting
is recorded and reported on financial statements. When every company follows the same
framework and rules, investors, creditors, and other financial statement users will have an easier
time understanding the reports and making decisions based on them.
1. Historical cost
Examples
– Pam’s Restaurant, LLC was formed in 1945. It purchased a building soon after in 1946 for
$20,000. Total, some 50 plus years later, Pam’s is still in business. The original building is still
on the balance sheet for $20,000 even though the current fair market value of the building is well
over $200,000. Pam’s will keep the building on its balance sheet for $20,000 until it is either
retired or sold.
– Jeff’s Construction, LLC bought a piece of equipment in 2001 for $10,000. Today this piece of
equipment is only worth $2,000. Jeff would still report the equipment at its purchase price of
$10,000, less depreciation, even though its current fair market value is only $2,000.
– Bill’s investment firm purchases several pieces of property in Brazil as an investment. Over the
last five years, the Brazilian currency has been in double-digit inflation and the investment is not
worth nearly what Bill paid for it. The historical cost principle does not adjust asset values based
on currency fluctuations, so the property would still be reported as the original purchase price.

Accounting Principles

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Accounting Principles

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Accounting principles

List of 10 Basic Accounting Principles

Historical Cost Principle

Full Disclosure Principle

Cost Benefit Principle

List of Key Accounting Assumptions

Monetary Unit Assumption

Fundamental Accounting Concepts and Constraints

Business Entity Concept

Going Concern Concept

Industry Practices Constraint

Why Are Accounting Principles Important?

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