Accounting is the recording of the financial transactions of a business or organization. It also involves the process of summarizing, analyzing, and reporting these transactions in financial statements. These financial statements are critical for the work of bookkeepers at a business or organization. It is a highly regulated field and accounting must be conducted according to standard accounting principles such as accrual, conservatism, consistency, cost, economy entity, full disclosure, going concern, matching, materiality, monetary unit, reliability, revenue recognition, and time period.
The accrual principle is the idea that accounting transactions must be recorded in the period in which they occur not simply in the period in which there are associated cash flows. This principle is vital to creating accurate financial statements. Ignoring this principle could mean that the expenses reported only upon payment would lead to a delay caused by the payment terms for the associated supplier’s invoice.
The conservatism principle indicates that expenses and liabilities must be recorded as soon as possible, but to only note revenues and assets when an accountant is certain that these revenues and assets will definitely materialize. This principle could lead to lower reported profits since revenue and asset recognition may be delayed. It may also encourage recording of losses sooner rather than later.
The consistency principle is the idea that once an accounting principle or method is adopted by a company it should continue to be used until a better principle is found. By not following the consistency principle, a business could continually switch between principles of its transactions and make its long-term financial results difficult to recognize.
The cost principle is the idea that a business should only record its assets, liabilities, and equity investments at their original purchase costs. However, this principle is becoming less valid due to the fact that a number of accounting standards are adjusting assets and liabilities to their fair market values.
The economic entity principle is the concept that the transactions of a business should be separate from those of its owners and other businesses. This would prevent mixing assets and liabilities among multiple entities which can result in difficulties when the financial statements of a new business are first audited.
The full disclosure principle is the idea that financial statements should include all of the information that could affect a reader’s understanding of those statements. This principle has been elevated due to the fact that it could specify a large number of informational disclosures.
The going concern principle states that a business should remain in operation for the foreseeable future. A business owner would then be within their rights to defer the recognition of some expenses such as depreciation until a later date. If this did not occur then all expenses would have to be recognized at once and not deferred.
The matching principle is the idea that once revenues are recorded, related expenses should be recorded at the same time. For example, inventory would be charged to the cost of goods at the same time that a business owner received revenue from the sale of such inventory items.
The materiality principle is when transactions should be recorded in the accounting records if not doing so might affect the decision-making process of a person reading the company’s financial statements.
The monetary unit principle is the idea that a business should only record transactions that can be declared to be in the terms of a unit of currency. It is simple enough then to record the purchase of a fixed asset since it was bought for a specific price.
The reliability principle holds that only transactions that can be proven should be recorded. A supplier invoice would be sufficient evidence that an expense has been recorded. This is a vital principle for auditors who need the evidence to support transactions.
The revenue recognition principle is the idea that revenue should be recognized only when the business has completed the earnings process. However, this principle has been used to commit reporting fraud thus standard-setting entities have developed a large amount of information about what is considered proper revenue recognition.
The time period principle is the concept that a business should record the results of its operations over a standard period of time. It is meant to create a normalized set of comparable periods when can then be used to analyze trends within the given period.
In a business an accountant must prepare reports for the chief financial officer or CFO so that the CFO can then present this information to analysts within the given industry. Analysts then proceed to determine how valuable and financially healthy the company is. Brokerage firms are contacted by analysts to figure out stock prices for the company. Also, accountants have to prepare annual statements that investors, auditors, and the Internal Revenue Service use to place a value on the company, regulate it, and tax it.
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