Accounting Concept and Principles
When it comes to financial reporting, a fundamental structure has been developed that consists of a set of broad based standards and protocols known as accounting principles and concepts. Typically, financial reports are based on sound decision making and astute observations by accountants. These set of conventions, standards and protocols ensure that the end users of this financial information are not led astray when they adopt financial policies and frameworks that are in contradiction to the spirit of accounting. Therefore, it becomes paramount for accountants to ensure that the accounting practices and work ethics adopted by them are compatible with the fundamental principles and concepts of accounting.
Prominent accounting regulatory institutions have integrated these accounting principles and concepts into the reporting templates; IASB framework is an example of such a framework.
Here is a list of the prominent accounting principles and concepts:
This principle makes it imperative that the accounting information is related to the decision making requirements of the users of the financial systems. It should assist them in making future forecasts of the market trends or lending credence, verifying or rectifying the past forecasts that have been made.
If a user of the financial system is able to bank on an accounting information to make accurate and sound judgements and if it portrays the actual information that it endeavors to represent, then the said accounting information is believed to be reliable.
If the accounting information depicted in financial statements and judgements is verifiable by independent of third party accountants, then such information is said to be verifiable.
The financial statements and judgements should incorporate accounting information that is void of any bias. It should depict a well-articulated perspective of the company affairs without endeavoring to portray them with adulteration.
Prudence demands that accountants stay cautious while adopting policies and conducting approximations so that the assets and income of a company are not overemphasized while liability and expenditures are not under stated. A company should not consider an asset at a value that is higher than that expected to be recovered from its use or sale and liabilities should also not be rated lower than their actual value.
Financial statements should portray the actual transactions and events that transpire during a certain period. They should be accounted for in a way that they represent the actual economic stature instead of the legal shape with candor.
Substance over legal form
The economic status of transactions and events must be stipulated in financial statements and judgements instead of their legal shape in order to portray an actual and candid perspective of the affairs of a company.
An accounting information can only be deemed reliable if it is complete in relation to an entity and renders the environment conducive for users of the financial system to make decisions. A financial information that is not complete, suppresses its reliability and relevance.
Comparability or consistency
Users of a financial system can only deduce substantial conclusions out of financial statements if they are consistent with those of the other period regarding the trends in a company’s financial turnover. This comparability and consistency can be achieved by adoption of similar accounting principles and concepts over a period of time.
Matching principle and concept
The expenditures incurred by an entity in an accounting period must be charged to the income statement in which the turnover related those expenditures is earned. It portrays an accurate and balanced perspective of the financial output of an entity in comparison with that obtained from cash basis of accounting.
Accrual concept demands that the income and expenditures must be recognized in the accounting periods to which they are related instead of being related to on the basis of cash. This concept demands that income must be incorporated in the accounting period in which it is earned.
It is also referred to as revenue recognition principle and states that turnover is considered by the seller when it is earned regardless of whether cash from the transaction or event has been received or not. It depicts the actual extent of revenue rather than the cash flows produced that can also be determined from the cash flow statement.
Financial transactions and events should be incorporated in financial statements and judgements in a way that is comprehendible by a user of the financial system who is cognizant of the enterprise, economic activities and accounting.
The accounting information must be furnished to the users of the financial system in time to ensure that they are able to make the right judgements at the right time.
The materiality of information is defined by its effect on the decision making process of the users of the financial system in case it is omitted or represented in an unacceptable way. It determines the threshold after which financial judgements becomes related to the decision making requirements of the users of the financial system.
It is also referred to as the measurability concept and implies that financial transactions and events can only be measured in terms of money.
It is the original cost of an asset that was obtained in the past. The historical cost convention dictates that the assets should be considered at their historical costs. It may be regarded as the default value assigned to assets.
It is one of the basic assumptions in accounting which is used to formulate financial statements. They are developed with the assumption that an enterprise will continue to function in the coming future without the need of the entity to be liquidated emerging or to cut down on its operational activities.
Duality principle is another basic concept of accounting that makes it mandatory that all aspects of an accounting transaction and event are considered. It forms the very basis of the double entry accounting system. This system considers two types of transactions, namely: credit and debit.
Single economic entity
This concept states that entities related to each other via common control function as a single economic unit and so the combined financial statements of a conglomerate of entities portrays the basic idea behind this arrangement.
The business entity concept suggests that the financial transactions and balances of a business entity are to be accounted for distinctly from those of its owner. Therefore, when it comes to accounting, a business entity is entirely separated from its owner. That is why an owner’s equity is placed on the liability side of a balance sheet.
If one or more of the accounting concepts and principles are in contradiction to each other, it is the responsibility of the accountant to figure out what is best for the users of the financial system. For instance, financial system may be more relevant if it is shared in a timely manner. However, it will take more time for the information to be collected. So, it all boils down to the astuteness of the accountant to figure out whether a compromise on the reliability of information is worth it or whether he or she wants to go for the relevance of the accounting information as the primary choice. The decision is taken in the best interests of the users of the financial system.