Ultimate Guide to Understanding and Implementing Accounting Principles

If you want to succeed in the business world, it's extremely important to have a basic understanding of various accounting principles and how to use them in the real world. Keeping track of and reporting financial information correctly is one of the most important duties that a business owner has, and using these principles will help fulfill all financial and legal obligations you have. From handling business transactions to making a profit, the world economy relies heavily on the basic principles of accounting, and without these accounting standards our global economy would quickly grind to a halt.

From GAAP (generally accepted accounting principles) to IFRS (international financial reporting standards), there is a lot of technical language and jargon that accountants use, but the average person can still easily begin implementing them in their business to make it more profitable, future proof, and ensure that all regulations are met. So, whether you're a business owner, a financial expert, or simply someone who recognizes the value of money and stability in life, these accounting principles will help you achieve your goals, grow your income stream, and become a more effective earner and business owner.

What Are Basic Accounting Principles?

Put simply, accounting principles are the regulations, rules, laws, and guidelines that must be followed when business entities like a company reports financial statements and records financial transactions. When it comes to accounting standards, the IFRS are the most widely used worldwide, while the GAAP standards, issued by the Financial Accounting Standards Board, are generally specific to the United States. These two sets of rules aim to standardize the language and tools used to report financial data, making it easier to examine and understand how companies are earning their money.

These standards allow for greater comparability, where the records of various companies can be compared side-by-side more easily to find discrepancies or issues. A company's financial statements are subject to examination and scrutiny by the Internal Revenue Service, the Governmental Accounting Standards Board, and other regulatory agencies, which help guard against fraud or financial abuse.

Let's take a look at some of the most important of these standards, how they work, and how you can use them to improve your business, life, and income.

Top Seven Most Important Accounting Principles

Within the GAAP and IFRS standards, there are a few well-defined and simple principles or guidelines that must be followed. These standards aren't only used to examine financial statements for fraud, they also encompass generally solid business practices that will benefit any company that uses them. Keeping an accurate and transparent record of transactions helps businesses understand what needs work, what can be streamlined, and allows for more accurate predictions and forecasts of the foreseeable future.

Principle #1: The Revenue Recognition Principle

One of the most important parts of GAAP has to do with revenue recognition, or how and when to recognize earned money as revenue along with how to document and report it. Because a company's revenue is so important to its overall success, many businesses attempt to inflate it by using potentially fraudulent ways to increase the cash flow on their balance sheets.

This principle ensures that money is only reported when it is fully earned, not just when it is promised to a company. Essentially, it makes it so that income can only be reported properly when the goods and services are fully complete or delivered.

Principle #2: The Matching Principle

The matching principle is related to the previous principle in that it has to do with earned revenue and how to properly report it. The matching principle states that any business expenses should be reported in the same accounting period as the money that is earned from them. This helps keep track of expenses versus profits more accurately and ensures that the company can show that its costs match up with the money it makes.

So, under this principle, business expenses are reported in the same period that any related revenues are made, liabilities or debt are reported at the end of the accounting period, and expenses not tied to any revenue, like rent or utility bills, should be reported in the same period as when they were used. This standard ensures that a company's financial statements accurately show how they are spending, saving, and earning money, and are necessary to meet the international accounting standards board requirements and other regulations.

Principle #3: The Consistency Principle

The consistency principle requires that the basic accounting standards used by a company shouldn't change often or arbitrarily, and all financial statements and records should be carried out using the same standards from period to period. This helps ensure that financial reporting can be easily checked or examined from year to year by those who are designated to do so.

Now, if a company does want to change an accounting method or the way they handle their accounting data, the consistency principle doesn't mean that they can never do so. Rather, it simply means that they need to document the change, disclose it to all relevant parties, and explain why they are making the change. This principle is especially important to auditors as going over a balance sheet or income statement that is different from the other years or one that changes regularly can be very difficult.

Principle #4: The Cost Principle

The cost principle has to do with how assets are initially recorded and valued in a company's financial records. Assets that are acquired by a company must generally be recorded at their historical cost, which is the purchase price and any other direct expenses to bring the asset into use.

While it's true that the value of assets can change over time due to inflation or other economic indicators, the cost principle mainly focuses on the initial valuation or recording of an asset's value. This prevents over-inflation of a company's financial statements, where the company might try to appear to be worth more than it really is.

Principle #5: The Materiality Principle

The materiality principle has to do with financial reports and how you report your financial documents, related expenses, asset valuations, financial results, cash flows, and other financial indicators to the responsible government agencies or other parties like investors or shareholders. Many of these accounting principles deal with reporting and keeping track of money, as that is the major role of an accountant.

The materiality principle states that accountants must provide all material financial information that could affect the decision making process of the company, investors, or other relevant people. The IFRS defines information as "material", meaning it must be reported under this principle, if "omitting, misstating or obscuring it could reasonably be expected to influence the decisions that the primary users of general purpose financial statements make".

Principle #6: The Accrual Principle

The accrual principle is similar to the issue of revenue recognition but has a broader scope. This principle ensures that both revenue and expenses are recorded and reported when they are either earned or incurred, which might not be exactly when the money is exchanged.

This accrual basis for transactions extends the criteria for recognizing transactions beyond revenue to encompass expenses as well when preparing financial statements. This approach ensures that a comprehensive chronological timeline of all financial transactions is reported accurately and in the proper framework, not just revenue.

Principle #7: The Full Disclosure Principle

The full disclosure principle is related to the materiality principle in that it also has to do with what information should be disclosed to shareholders or relevant parties, but its scope and purpose are broader. While the materiality principle has to do with financial statements and reporting, the full disclosure principle covers a wider range of accounting records and other information that both public companies and private companies deal with.

Some of this information includes contingent liabilities, related-party transactions, fair value measurements, leases, employee benefit plans, and any other liabilities that the company has. While companies might want to cover these issues up as it could make them less attractive to buyers or shareholders, this accounting principle ensures that all relevant information, even when it could hurt the company, is disclosed.

Make These Accounting Principles Work For You

From publicly traded companies to small mom-and-pop shops, these accounting standards are critical for success. If you're not familiar with them, basic accounting software can help with some of these areas, or you may want to consider contacting accounting specialists for assistance.

If you fail to properly keep track of your money flow, record transactions, and make sure that all legal and financial obligations are met, your business could waste money, miss profits, and rack up huge liabilities that can cause issues in the future. Before it gets to that point, it's important to be proactive about how you record and report transactions and the economic health of your company. Contact an accountant today and get the process of streamlining, organizing, and understanding your financial data and records started!