Accounting is called the language of business that which communicates the financial condition and performance of a business to interested users, also referred to as stakeholders.
In order to become effective in carrying out the accounting procedure, as well as in communicating the financial information of the business, there is a widely accepted set of rules, concepts and principles that governs the application of the accounting procedures, and it is referred to as the Generally Accepted Accounting Principles or GAAP.
In this article, you will learn and familiarize yourself with the accounting principles and accounting concepts relevant in performing the accounting procedures. It is relevant to understand it because you need to abide by these concepts and principles every time you analyze record, summarize, report and interpret financial transactions of a business.
Guidelines on Basic Accounting Principles and Concepts
GAAP is the framework, rules and guidelines of the financial accounting profession with a purpose of standardizing the accounting concepts, principles and procedures.
Here are the basic accounting principles and concepts under this framework:
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, vice versa. 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, assets are recorded based on their original cost and not on market value. Assets are assumed to be used for an indefinite period of time and not intended to be sold immediately.
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 of a business over a specific operating time period. It 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 valuation of business transactions, the amount recorded should be the lower rather than the higher value.
This principle ensures consistency in the accounting procedures used by the business entity from one accounting period to the next. It allows fair comparison of financial information between two accounting periods.
Ideally, business transactions that may affect the decision of a user of financial information are considered important or material, thus, must be reported properly. This principle allows errors or violations of accounting valuation involving immaterial and small amount of recorded business transaction.
This principle requires recorded business transactions should have some form of impartial supporting evidence or documentation. Also, it entails that bookkeeping and financial recording should be performed with independence, that’s free of 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.