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Accounting Principles (Explanation & Examples)

According to AICPA, accounting principle is a general law or rule adopted or processed as a guide to action.

Thus, Accounting Principles refer to the rules or guidelines adopted for recording and reporting of business transactions, in order to bring uniformity in the preparation and the presentation of financial statements.

For example, one of the important rules is to record all transactions on the basis of historical cost, which is verifiable from the documents such as cash receipt for the money paid. This brings in objectivity in the process of recording and makes the accounting statements more acceptable to various users.

Accounting Principles have evolved over a long period of time on the basis of past experiences, usages or customs, statements by individuals and professional bodies and regulations by government agencies, and have general acceptability among most accounting professionals.

However, the principles of accounting are not static in nature. These are constantly influenced by changes in the legal, social and economic environment as well as the needs of the users

The accounting principles do not prescribe one way of doing things. They recognize that there are a number of ways in which one thing can be done.

An accountant has considerable latitude and choice within the generally accepted accounting principles in which to express his own idea as to the best way of recording and reporting is specified account. The practice of recording and reporting may thus differ from company to company.

Features of Accounting Principles

The general acceptance of an accounting principle or practice depends on its capacity to meet the criteria of relevance, objectivity, and feasibility.

Relevance

An accounting principle should be relevant, i.e. the use of it should result in information that is meaningful and useful to the financial statement users.

In other words only those accounting rules which increase the utility of the business records to its readers will be accepted as an accounting principle by them.

Objectivity

It should be objective. The accounting information obtained should not be influenced by the personal bias or judgment of the statement makers.

Objectivity can note reliability or trustworthiness. It means that there must be means of ascertaining the correctness of the information reported in a financial statement.

Feasibility

A principle is feasible to the extent that it can be implemented without undue cost or complexity. The accounting principles may be adopted to the needs of the business quickly and easily.

It means the accounting principles should be flexible, i,e. they should not be static. They should be capable of being changed with the changes in business methods and procedures.

These principles are also referred as concepts and conventions.

The term, concept refers to the necessary assumptions and ideas which are fundamental to accounting practice, and the term, convention connotes customs or traditions as a guide to the preparation of accounting statements.

In practice, the same rules or guidelines have been described by one author as a concept, by another as a postulate and still by another as a convention.

The important principles or concepts have been listed below:

Business Entity Concept

Business entity means that business has its own entity, has its own existence. It means that for the purposes of accounting, the business and its owners are to be treated as two separate entities. Keeping this in view, when a person brings in some money as capital into his business, in accounting records, it is treated as a liability of the business to the owner. 

For example;

Mahesh started a sole proprietorship business with capital of Rs. 100000 by depositing into the bank. What is the journal entry for the transaction?

Analysis of Transaction: In the transaction, two accounts are involved capital account and bank account.

The capital account is a representative personal. It represents Mahesh who is the owner of the business. Bank account is an artificial personal account.

In the transaction, Bank is the receiver of the money, so bank account will be debited with Rs. 100000 and Mahesh is the giver of the money, so capital account will be credited with Rs. 100000.

Bank account                Dr 100000
          Capital account                       Cr 100000
(Business started with capital of Rs. 100000)

Thus the owner’s private affairs are not allowed to be mixed up with those of the business. It is only because of this principle that we are able to present a true picture of the firm. The entity concept is applicable to all types of business entities. There are three papular types of business entities.

  1. Sole proprietorship 
  2. Partnership firms
  3. Company 

Sole proprietorship and partnership don’t have a separate legal existence from their owners but for accounting purposes, we treat both as separate entities. 

So accountants keep the book of accounts from the point of view of the business unit and not that of the owner. The personal assets and liabilities of the owner are, therefore, not considered while recording and reporting the assets and liabilities of the business.

Similarly, personal transactions of the owner are not recorded in the books of the business, unless it involves inflow or outflow of business funds.

The field of this concept has now been extended. It is now also applied for finding out the results of various departments of the same organization separately with a view to fixing the responsibility for the results thereof.

Money Measurement Concept

All business transactions are recorded in terms of money. This concept is called the money measurement concept.

The money measurement concept states that only those transactions and events in an organisation which can be expressed in terms of money are to be recorded in the book of accounts.

All such transactions or happenings which can not be expressed in monetary terms do not find a place in the accounting records of a firm.

Money is the only factor common to all business transactions, and thus it is the only unit of measure capable of producing financial data that can be compared.

The monetary unit a business uses depends on the country in which the business resides. For example, in the United States, the basic unit of money is the dollar. In China, it is the yuan; in Japan, the yen; in the European Union (EU).

In international transactions, exchange rates must be used to translate from one currency to another. An exchange rate is the value of one currency in terms of another.

Going Concern Concept

There are certain expense and revenue transactions are allocated over several years. Choosing the number of accounting periods raises the issue of continuity.

What is the expected life of the business? Many businesses last less than five years, and in any given year, thousands of businesses go bankrupt.

The majority of companies present annual financial statements on the assumption that the business will continue

In accounting, an entity is said to be a going concern if it is assumed that it will continue in business for the foreseeable future for at least the next 12 months from the accounting year-end. If this is not the case, then different accounting procedures would be adopted.

Accounting Period Concept

Accounting period refers to the span of time at the end of which the financial statements of an enterprise are prepared, to know whether it has earned profits or incurred losses during that period and what exactly is the position of its assets and liabilities at the end of that period.

Financial statements may be prepared for any time period, but generally, to make comparisons easier, the periods are of equal length.

A 12-month accounting period is called a fiscal year; accounting periods of less than a year are called interim periods. 

An accounting period (also called a reporting period) is the time between two successive balance sheet dates. 

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