Accounting 101: Principles

Welcome back to Accounting 101! To get started we are going to review the core accounting principles. These principles form the foundation of the accounting framework. Sometimes two or more principles may be at odds. A CPA must use professional judgement in choosing how and when to apply these principles.

Accrual:

Accrual means to recognize transactions in the period incurred, not when cash changes hands.

Matching:

The matching principle is one of the most important principles in the accrual basis of accounting. It means that income and the related expenses are recorded in the period incurred or used.

Revenue Recognition:

Revenue is recognized and recorded in the accounting system in the time period when the item is sold or the service is performed (not when the item was purchased or the cash for the sale was collected).

Materiality:

Materiality means an amount that would influence the decisions of financial statement users. The amount varies by the size of the business, type of transaction, and dollar amount. All material transactions must be reported correctly. In an audit, a CPA is required to search for material misstatements.

Conservatism:

Taking a cautious approach is valuing assets, liabilities, and other business transactions. If there are multiple ways equally qualified ways to record a transaction, this principle dictates taking the most conservative position.

Timeliness:

Timeliness is balanced with accuracy. Financial reports are most useful once they are completed, however they should not be issued until all material information is available. 

Consistency & Comparability:

Choosing an accounting method and following it year after year. This allows financials statements from multiple years to be comparable. This applies to how individual transactions are handled and overall reporting.

Objectivity:

Transactions should have supporting documentation to collaborate what is recorded. Accounting services should be performed without bias.

Independence:

For some work a CPA does they must be independent of management and perform their services without bias. A CPA must be independent in fact and appearance.

Business Entity:

A business is separate from the owners. It is its own legal and financial entity.

Monetary Unit:

Transactions that can be quantified in a currency are recorded in the accounting system. The financial reports must be stated in one currency.

Cost/Historical Value:

A transaction is recorded at the cost originally spent or obtained. This principle means that assets or liabilities are not adjusted for inflation or changes in market value, except for stocks and bonds.

Going Concern:

A business that is a going concern has a high risk of going bankrupt in the foreseeable future. CPAs are obligated to voice going concern issues, but it is primarily a legal question.

Time-Period:

Accounting services and reports are prepared on a regular basis, be it monthly, quarterly, or annually. The time-period must be shown on each financial statement. Most companies use the calendar year as their fiscal year.