Accounting is referred to as “the language of business” because it communicates the financial condition and performance of a business to interested users.
In order to become effective in carrying out the accounting procedure, as well as in communication, there is a widely accepted set of rules, concepts and principles that governs the application of the accounting. These concepts and principles are referred to as the Generally Accepted Accounting Principles or GAAP.
In this article, you will learn and familiarize yourself with the accounting principles and concepts relevant in the performance of the accounting procedures. It is a necessity to learn and understand it because you need to apply these concepts and principles during the accounting process.
Guidelines on Basic Accounting Principles and Concepts
GAAP, is the framework and guidelines of the accounting profession. Its purpose is to standardise the accounting concepts, principles and procedures.
Here are the basic accounting principles and concepts:
1. Business Entity
A business is considered a separate entity from the owner(s) and should be treated separately. Any personal transactions of its owner should not be recorded in the business accounting book unless the owner’s personal transaction involves adding and/or withdrawing resources from the business.
2. Going Concern
It assumes that an entity will continue to operate indefinitely. In this basis, generally, assets are recorded based on their original cost and not on market value. Assets are assumed to be held and used for an indefinite period of time or during its estimated useful life. And that assets are not intended to be sold immediately or liquidated.
3. Monetary Unit
The business financial transactions recorded and reported should be in monetary unit, such as US Dollar, Canadian Dollar, Euro, etc. Thus, any non-financial or non-monetary information that cannot be measured in a monetary unit are not recorded in the accounting books, but instead, a memorandum will be used.
4. Historical Cost
All business resources acquired should be valued and recorded based on the actual cash equivalent or original cost of acquisition, not the prevailing market value or future value. Exception to the rule is when the business is in the process of closure and liquidation.
This principle requires that revenue recorded, in a given accounting period, should have an equivalent expense recorded, in order to show the true profit of the business.
6. Accounting Period
This principle entails a business to complete the whole accounting process over a specific operating time period.
Accounting period may be monthly, quarterly or annually. For annual accounting period, it may follow a Calendar or Fiscal Year.
This principle states that given two options in the amount of business transactions, the amount recorded should be the lower rather than the higher value.
This principle ensures similar and consistent accounting procedures is used by the business, year after year, unless change is necessary.
Consistency allows reliable comparison of the financial information between two accounting periods.
Business transactions that will affect the decision of a user are considered important or material, thus, must be reported properly. This principle states that errors or mistakes in accounting procedures, that which involves immaterial or small amount, may not need attention or correction.
This principle states that the recorded amount should have some form of impartial supporting evidence or documentation. It also states that recording should be performed with independence, that’s free from bias and prejudice.
This principle requires that revenue should be recorded in the period it is earned, regardless of the time the cash is received. The same is true for expense. Expense should be recognized and recorded at the time it is incurred, regardless of the time that cash is paid. This is to show the true picture of the business financial performance.