People often assume that accounting is a separate domain that deals with budgeting and finances, best left to professionals. That’s not true because accounting principles and knowledge empower a business owner with financial-savviness and sound decision-making skills. Accounting practices are a prominent feature of trade and commerce, dating back to ancient Mesopotamia.
Accounting principles and practices formally emerged during the 1800s, and today, they form the crux of bookkeeping and sustainable profitability. Whether you sell tech-savvy gadgets, clothing, or run a pet shop, accounting practices are highly relevant to your business.
You can either hire an accountant or embrace the essential accounting principles to empower yourself with transparency and information. Keep reading to understand the heart of business accounting principles that drive profitability.
THE REVENUE PRINCIPLE
One of the underlying principles of business accounting, the revenue principle, identifies the time of recording a transaction. When can a business record a business transaction as revenue in the books? According to the revenue principle, when a sale occurs only then it needs to appear in the document.
Accountants record revenue when a buyer legally takes possession of the product or enjoys the service. Contrary to what most people believe, cash transactions do not get in the record as revenues upon receiving money from the buyer. The other name of this principle is the revenue recognition principle.
THE EXPENSE PRINCIPLE
The expense principle or expense recognition principle identifies when a business can log an expense in the books. This principle dictates that an outflow occurs when a business buys products or services from another company. It gets recorded when the products come in possession, or the service gets performed. A seasoned accountant understands the significance of the expense principle in balancing expenses and income to ensure profitability. If you have basic knowledge of the expense and revenue principle, it’s lucrative to explore higher education and specialization. There’s a growing demand for seasoned accountants. Today, you can pursue an online masters in accounting no gmat requirements to avoid making unbacked decisions. The principles we are explaining right now will serve as a foundation for developing a thriving career.
THE MATCHING PRINCIPLE
The matching principle dictates that an accountant must match each revenue-generating item with an expense-generating item. For instance, if your business sells cakes, you must account for the expense of chocolate, flour, and other ingredients. Simply put, the cost of the mixings must match the revenue generated by selling the cake.
An accountant applies the revenue, expense, and matching principles during the accrual accounting methodologies. These principles are instrumental in balancing income and expenditures to ensure profitability.
THE COST PRINCIPLE
The cost principle is a powerful method of evaluating assets and accounting for depreciation.
All businesses own assets, and the worth of their assets determines their liquid value. According to the cost principle, all items are recorded based on their historical cost rather than the resale value. Why is that?
For instance, if your business owns vehicles or property, they will be listed with their historical cost. The accountant will not take into account the current fair market value to account for depreciation.
THE OBJECTIVITY PRINCIPLE
This principle guides accountants towards fact-checking and scientific techniques to ensure objectivity. Seasoned accountants understand the significance of avoiding subjective value measurements. Accounting is firmly grounded in verifiable and objective data.
There are scenarios where subjective data seems more credible and appealing. But an accountant must always maintain objectivity and seek out verifiable data backed by facts and figures.
THE ACCRUAL PRINCIPLE
This principle is the foundation of the accrual basis of accounting. It’s vital for creating transparent and accurate financial statements that reveal transactions that occur during an accounting period. The accrual principle states that all transactions must come in the record during the accounting periods of their occurrence. It negates recording transactions during the periods of cash flows.
It’s normal for transactions to get artificially delayed or sped-up due to their associated cash inflows and outflows. For instance, if a business records an expense when it pays for it, it ignores the accrual principle. How can this create complications? It will create lengthy delays in balancing the financial statement because the accountant will have to wait for the supplier invoice.
The supplier invoice is crucial for recording purposes and defining the payment terms.
THE CONSERVATISM PRINCIPLE
All businesses deal with assets, revenues, liabilities, and expenses. The conservatism principle deals with all these cash inflows and outflows. This principle states that a company should record its liabilities and outgoings without delay. However, businesses should record revenues and assets when they have occurred with certainty and evidence.
This principle gives a conservative outlook to financial statements that often underreports profits because of the delays in recognizing assets/revenues. It’s a famous principle that stresses recording losses and liabilities at the earliest rather than later. This principle helps businesses drive profitability and adopt an efficient debt management approach.
THE CONSISTENCY PRINCIPLE
Much as the name implies, the consistency principle refers to the consistent adoption of a chosen method. It dictates that accountants should continue using an accounting principle until they identify better principles with demonstrable advantages.
The consistency principle is instrumental in establishing consistency and transparency. Jumping between new techniques and different accounting methodologies creates disparities in transactions. Ultimately, the use of multiple methods makes a hotchpotch of indiscernible financial results.
THE FULL DISCLOSURE PRINCIPLE
Accounting is all about disclosure and transparency for all stakeholders, including entrepreneurs, customers, employees, investors, shareholders, and the government. The full disclosure principle dictates the need for informational disclosure in presenting financial information and disclosing liquidity data.
Modern-day accounting standards are inspired and improved by the evolution of this concept. It holds immense significance in corporate compliance and transparency.
THE GOING CONCERN PRINCIPLE
This principle states that a company will remain operational for the short-term or long-term future. It justifies deferring the recording of certain expenses, mainly depreciation, until a later time. It allows businesses to defer individual outflows rather than recording all of them at once.
These accounting principles dictate how a business can comply with financial disclosures and share its financial information. Adopting accounting principles and methodologies defines how a company records and presents its revenues and expenses. A seasoned accountant is well-versed in all accounting principles and understands how to use these principles to benefit a business.
Recording assets, income, liabilities, and expenses require an accountant to deal with multiple principles and methodologies. The chosen principles have a profound impact on a businesses’ financial forecasting and decision-making processes.