Accounting is an essential part of every business. It is the way to keep track of your income and expenses. Hiring an accountant does not exempt business owners from the responsibility to understand basic economic operations. That’s why knowing basic accounting principles is essential for entrepreneurs. You should also read good accounting books to improve your knowledge.
It gives the possibility to not only to understand the methods that your accountant uses but also to prevent money loss. Business owners should learn from numbers and monitor the whole situation.
There are some generally accepted principles including economic entity, specific time assumptions, cost and full disclosure principles, materiality, and conservatism.
Let’s take a closer look at these 10 basic accounting principles. So, you can better understand what your accountant is taking care of and how to manage your business finances on your own.
Top 10 Basic accounting principles and concepts
1. Economic Entity Assumption
The principle of economic entity assumption states that business owners should keep their personal transactions separately from business transactions. There should be two different bank accounts since there is no place for haphazard spending. All business transactions should be associated with an entity even in the case of the sole proprietorship. It helps to keep a record of your business expenses and estimate your tax liability.
2. Monetary Unit Assumption
The principle of monetary unit assumption states that all transactions should be expressed in one currency. If you run your business in the U.S., the economic activity is recorded exclusively in U.S. dollars. It gives the possibility to ignore an increase in the general price level, also known as inflation. The purchasing power of U.S. dollars (in our case) remains the same during the whole time.
3. Matching Principle
The concept of the matching principle is considered to be a cornerstone of the accounting world. It states that you need to record all your expenses once you calculate your revenue. This also refers to entrepreneurs who operate their business on a cash basis.
Your accountant still needs to report about the finances based on the accrual basis accounting. The matching principle helps to keep a record of your business’s performance in the market. It can also give you an insight into the profitability of your company.
The principle of conservatism in accounting helps decision-makers to remain objective and act in the business’s interest. Sometimes there is more than just one way to record the transaction. So, in some situations, an accountant can choose a plan of action in order to prevent potential losses. Nonetheless, the accountant is still obligated to fulfill his duties in accordance with the rules and regulations
5. Full Disclosure Principle
The principle of full disclosure excludes any false accounting. You need to disclose all relevant information to lenders and investors since they need to see clear financial statements of your business in order to monitor the situation. It is considered a basic accounting principle, so all the footnotes should be attached to the official financial statements.
6. Revenue Recognition Principle
The revenue recognition principle states that all revenues should be recorded once service is performed or the product was sold to the customers. In this case, it doesn’t matter when payments are deposited into the business owner’s bank account. The customer can pay the next day or within thirty days, yet still, it should be recognized immediately. Please, don’t mistake revenue with a receipt.
In the case of materiality, the principal accountant should use his best judgment in order to address an error or record the transaction. In most cases, using professional opinions is essential. It helps to define the immaterial or insignificant amount and act according to regulations. For instance, material and immaterial expenses can be recognized in a different way. In the second case, it should be depreciated over time.
8. Time Period Principle
When it comes to accounting, all the results of business operations should be reported according to the instruction – over the same period of time. The principle of time period helps to analyze financial statements. Every balance sheet should include specific dates.
9. Going Concern Principle
Going concern principle is also called the ‘non-death principle’. It means that the accountant should analyze the situation and inform the owner. Whether the business is about to be liquidated or not. It allows the business owner to implement measures immediately in order to prevent collapse.
10. Cost Principle
A professional accountant can distinguish costs from value. For instance, the business owner can buy the house, and its price can decrease or increase over time. However, financial statements will remain the same since the value of the purchase doesn’t change. Another important thing to keep in mind is that your accountant isn’t able to get you the full information about the current value of your company’s assets. You need to look for a third-party appraiser.
So these were the 10 principles of accounting. Hopefully, it was worth reading.