Sunday, 24 May 2020

Basic Accounting Principles: A Simple Explanation

accounting principles

Accounting principles are basic guidelines that present the standards for accounting practices. It narrates how to record the accounting transactions in the books of accounts and also how to prepare and report this accounting data to the users.

When we follow these accounting principles, the financial records of the company can accomplish uniformity among the other business organizations.

GAAP ( Generally Accepted Accounting Principles) Online business courses to jumpstart your future.

 Generally Accepted Accounting Principles (GAAP) consists of the sum of accounting conventions, rules, standards and procedures. All those principles are used to formulate the financial statement of the business organizations.

GAAP is used as a standard set of measurement for compiling business accounts.

We can see many regulatory organizations are involved and influenced in the development of GAAP in the United States of America.

The list includes the American Institute of Certified Public Accountants (AICPA), Securities and Exchange Commission (SEC), Financial Accounting Standard Board (FASB), Governmental Accounting Standard Board ( GASB), and also there will be some other influential organizations taking part in the development of GAAP.

When a person wishing to invest in a company, first, he will analyse the financial statements of the company.

He may compare the financial data with other companies or with companies in similar industries also.

As the companies are following a general set of principles and conventions, it will help the investors to analyse the financial data easily. 

You know the small business organisation operating in your city, records their transactions in their books of accounts.

Substantially in the same e way, the global business giants working in different countries also record their financial data in their books of accounts.

This similarity and uniformity are governed by the principles of accounting, which all the business organizations follow.

Accounting Conventions And Accounting to principles are the two terms used interchangeably by the users. 

Accounting Conventions are methods people commonly accepted in the recording of transactions.

These principles issued years back, still, not changed much.

  1. Basic Accounting Assumption

  2. Basic Accounting principles

  3. Modifying accounting principles

A. Basic Accounting Principles

1. Revenue Realization Concepts

Revenue recognition principle pronounces that the revenue surely receivable only records in the books of accounts.

Suppose, we received an advance payment of INR 50000. for a product, we can record it as by debiting the Cash or Bank account and crediting the Customer account. We can not credit the Revenue accounts until we supplied and delivered the product.

As per the Revenue recognition principle in accounting, the accountants need to follow this principle in their day to a day accounting job. Practices against this principle may lead to exorbitant profit in the books of the firm.

We can clear this concept with an example. We have an Accounting and Tax Consultancy service. We render consultation to our clients for a fee of INR 200000. The payment will be settled after three months.

We can not record the full amount as a Revenue for the company. Practically we know some cases of non-settlement of the full amount. So we need to consider the bad debt at a certain percentage on the total Receivable. say for example 5%. ( 200000 x 5% = 10000) . So this INR 10000 will be an expense and to record for the concerned period.

2. Matching concept of Accounting

We know every transaction have two parts,

Revenue &,


In Accounting principles, We need to recognize both effects for the same accounting period.  

Accountants need to follow this concept, otherwise, the Profit &Loss  Account may not show the exact profit or loss for the period. 

For example, Our electricity bill is due for March for INR 5000. We received it in April. As per the matching concept, we enjoyed the benefit of the electricity in March.

So the expenses also recorded in March even though we received it in April.

3. Concept of Full disclosure

If a company is facing a legal lawsuit in the court for a violation of the law of the land and it expects an adverse effect on the company. The business may be required to pay an enormous amount as a penalty to the government.

Normally, this information can not be recorded as a financial matter as, at present, we did not pay any fine to the Government. There will be a  chance in the future to pay.

As per the concept of full disclosure, the company needs to disclose this information to the public, if it considers material to the knowledge of investors. 

So an investor can assess the future liability of the company before investing these companies.

As per the full disclosure principle of accounting, the true and fair view of the state of affairs can be presented to the investors or stakeholders of the company.

So the accounts should ensure the consistency, materiality and objectivity of the accounting information.

4. Dual Aspect Concept of Accounting

A company called A ltd, ask (A Company can not ask, it is just for your understanding that both owner and the business is separate) Mr Alex to invest INR 100000 in it.

For a norman person, it is only a transaction like Mr Alex invested money in A ltd. Aper accounting principles, it is two transactions or events in the business

  1. Mr Alex invested in A ltd and, at the same time

  2. It has created an obligation from the part of A Ltd to Mr Alex for the amount of INR 100000

The dual aspect concept in accounting principles states that if there is a business transaction, it will generate two effects in the business. The effect will be in an equal amount.

5. Variable Objective Evidence Concept

When we examine an income statement or Balance sheet of the company, we can recognise that it is full of accounting information gathered from related accounts of the company.

All these accounting data have been entered by the Accounting team of the organization for the concerned accounting period. So each transaction must record with the support of documentary evidence.

All these documents must be verified independently. The Accounting principle helps to present dependable and reliable data in the financial statement.

6.Historical Cost Concept in Accounting

When you review the records of a company for a period 5 to 6 years, you can find that the price of a particular asset is showing at the actual purchase price till the end of the useful life of the asset. Usually, the price of almost all the assets will decrease over the years. 

But in accounting, we need to show the actual purchase price in the balance sheet and the corresponding depreciation also presented in the balance sheet.

7. Balance sheet Equation concept

We understand all business transactions have two parts. It may be the movement of resources from to the company or creation or settlement of obligations etc.

One effect is known as Debit and the other is known as credit 

Every transaction has these two effects in business.

Balance sheet equation is Assets = Liabilities

Read More: Learn Introduction to Financial Accounting Online

B. Basic Assumptions

1. Business Entity Concept

Simply speaking, a business owner and his business entity are different. At a glance, it may be a complex statement.

As per the accounting policy, the business organization records all the financial activities separate from its owners.

Suppose, the business owner withdraws funds from the business. The accountant will record it as a financial transaction, as it reduces the obligation of the business to its owners.

In recent times, this distinction can be found easily in case of limited companies. Limited companies treated as separate legal entities as per law.

So the business entity, owners and management are treated separately.

We can see some exceptions to this rule that, if you analyse a sole proprietorship or small business, we can not find a clear distinction between the financial affairs of the owner and business.

2. Going Concern Concept

As per the principles of  Accounting, the business is supposed to run for an indefinite period. When an accountant records the data in the books of accounts of the business, he needs to assume that this business is not to shut down shortly.

3. Money measurement Concept

We can record only those transactions which are measurable in terms of money. If the owner contributes his land for constructing the factory unless it is valued in terms of money, as per accounting principles,  it will not be recorded in the books of accounts.

It means we can record the absolute value of the money. Due to inflation, or some other factors, we will not be able to record the real value of money.

4.Accounting period concept

As per the Going concern concept, We have previously seen that the business is expected to run for an unlimited period. But we require to know whether the business is running in profit or loss or what is the current state of affairs of the business? And the level of cash flow etc. periodically.

It means that we need to define a period with starting and ending date for which need to prepare the financial position of the business.

This period is called the accounting period. It will be a 12 month period decided by the company from January to December. 

In India, normally the accounting period is starting from April to March.

Nowadays, almost all businesses use advanced accounting software to record the transactions. So we can even find the financial statement for almost all the periods like weekly, monthly, quarterly etc.

5. Accrual Concept

When ABC Consulting LTD,  provided an Accounting consultation to Synergy LTD  for INR 50000. As agreed by the parties, the Synergy LTD  will pay the fee for the consultation after 60 days. 

So far the ABC Consulting Ltd can claim the fee from the Synergy ltd as they provided the consultation on credit. This claim of the fee is called accrual of revenue.

C. Modifying Accounting Principles

1. Materiality Concept of Accounting 

A transaction or event can be material, in case the information about it will impact the decision of the investors of the business. A piece of particular accounting information is material for one business, but it may be immaterial for another business.

The materiality of the transaction also depends on the policy of the company. 

Purchases of a calculator for INR 2000 is material for a small company. They may treat it as an Asset for the business and depreciate it for 3-4 accounting years.

These purchases may be immaterial for a big company and they may treat it as an expense for the same accounting period.

2. The Concept of  consistency

This accounting principle says that business organization should not change the particular method of recording transaction from year to year. 

They have to use the same accounting procedure for a particular type of transaction over the accounting periods.

For example, if the company has charges depreciation based on Written Down Value method for the; last 3 years. They can not change the method of charging depreciation for this particular accounting year.

They need to follow a particular method consistently. Otherwise, they have to find the net changes in the financial statement on account of change in the method of preparation and adjusted.

3. Prudence Concept of Accounting

An accountant, as per the basic accounting principles, must be prudent while recording revenue or expense.

He must anticipate all the loss that may affect the business in case if there is a reason and can not forecast any profit with proper clarity.

So an accountant can delay the recognition of a sale or revenue until he is sure about it, and are required to record all the expenses and liabilities if there is a chance to incur.

This accounting concept says that financial information must be conservative and cautious figures.

For example, We are selling furniture to retail customers. suppose we had purchased  1000 chairs of INR 500 ( INR 500000 ) each for sale in the market by the end of the accounting period. But suddenly the market price of chairs has come down 450.

So the financial statement should record the price of the closing stock at the end of the financial year must be INR 450000. ( The stock should be valued at cost price or market price whichever is lower).

4. Timeliness Concept of Accounting

In this accounting principle, as the name indicates, all transactions must be recorded at the correct time in the correct book of accounts.  It must be presented at the right time to the stakeholders of the business.

A delay in recording may lead to manipulation or misleading information about the company.

This principle is essential while recording transactions of liquid cash, currencies or other types of liquid stock.

5. Industrial Practice

As we have different industries, each industry may have a unique set of accounting principles, conventions or assumptions. If there is a specific set of accounting principles there to practice, those businesses have to prepare their accounting records and financial statement at par with it.

For example, in the case of Insurance companies, we have to follow a separate format to find the surplus or deficit, banking companies also have to report their financial reports in particular ways.

At the end of the day, it all reflects the financial position of the business organization.

Conclusion Blockchain Certification

These are the main accounting principles, assumptions and conventions. All these are illustrated for an educational purpose. If you need to go into detail and are interested in the word of accounting and a career in accounting, register yourself with top accounting courses from prominent institutes. 

Qatar Airways