Understanding accounting principles and concepts provide a strong base for you to prepare a set of financial statements. Following accounting principles is necessary to meet the expectations of the stakeholders that really place trust in your professionalism. Let’s have a glance at the five basic principles of accounting.
Revenue recognition as accounting principles
Revenue recognition means the concept that revenue should only be recorded once you’ve actually earned it. For instance, if someone gives you $1200 for one year of service in January. You are not entitled to record the whole amount of $1200 at once in the month of January. But, you are entitled to record $100 in the month of January after you’ve delivered the services in actuality. Hence, you are only allowed to record the revenue for which you’ve performed the services. The rest of the amount will be recorded month-wise as you keep on providing services.
The concept is simple “it’s your revenue if you have earned it”
Matching concept as accounting principles
The matching concept states that expenses or revenue of period A should be recorded in period A. In other words, date of performing services and date of receiving services is important as it helps in allocating the period of revenue and expenses respectively.
For instance, you performed some services in the month of January and incurred an expense of $80. Now you wish to record $80 in the month of February because the profit of January is not good. If you do so, it will be against the matching concept.
It’s also common sense to record the sales and expenses of January in January and sales and expenses of February in February, that’s exactly against the marching concept.
Economic entity concept
The economic entity concept states that personal transactions are different from business transactions and both should be recorded separately in the financial records.
Let’s understand the economic entity concept with the help of a scenario. You have a laptop repairing shop where you provide services to your client. On the day you were on vacation in Mauritius and the hotel you were staying in got some problem with their servers. You told the manager that you are an expert computer repairer and help him out. Now, the manager was so happy that he paid you $300. When you come back to the office and now feeling confused if I should record $300 in revenue of the shop.
The answer is that you are not allowed to record the $300 in the revenue of the shop because it was earned by you in the personal capacity, not the business capacity.
Cost principles
The cost principle states that assets are recorded in the books on the actual cost that was incurred to bring them into the company. As per this concept, the market value of the asset is not relevant. Market value will only be considered when a transaction is carried out to sell the business.
Full disclosure
The concept of full disclosure states that all the necessary information related to business performance should be fully disclosed in the form of notes to the accounts. These disclosures aid the users of the financial statement in understanding the financial statements and making decisions based on fully explained disclosures.
Also read, dividend policy
