Accounting principles are used in the accounting world as guidelines for dealing with financial statements. They determine how the statements should be prepared when to measure the financial statements and what should be paid attention to when the preparation is being done. This paper will take a look at the accounting principles and how they apply to the content of financial statements.
The business entity / accounting entity principle seeks to distinguish the company and those who may own it or those who provide capital. It clarifies that a corporation is an independent entity and as such the liability of the company is limited to itself. Therefore, the liabilities of the company cannot be attached to the owners or capital contributors of the enterprise (Ittelson, 2009).
The going concern principle assumes that the lifetime of a business cannot be expressly defined. As a result, financial statements are prepared on the assumption that the company shall be in existence in the next financial period (Accounting Principles, n.d).
The money measurement principle brings out the quantitative nature of accounting whereby events and transactions must be recorded in monetary items. This principle is important because it allows several parties to have a complete image of the company’s events (Accounting Principles, n.d.)
The estimates and judgment principle recognizes the complex nature of businesses and leaves room for judgment. Expected errors in this case will not affect the validity of financial statements and reports. However, these guesses should be consistent for each period. (Ittelson, 2009).
The periodicity principle seeks to put time frames into the life of a business. This principle specifies that the company should operate in equal periods to allow for easier comparison of financials statement. This comparison is important for a business to establish weakness that need to be strengthened (Introduction to accounting, n.d).
The historical concept principle states that all transactions that result in acquiring assets and incurring liabilities should be recorded at the “historical cost” at which they were transacted with. This principle may cause financial statements to be understated especially in times of inflation.
The Units of measure principle seeks to set out the standard value to be used in all measurements. This principle primarily depend on the jurisdiction of the business such that a business operating within a certain country uses the local currency while multinationals more often than not, prefer to use the dollar as the standard measurement (Accounting Principles, n.d.).
The accrual principle states that expenses are recognized when they are incurred, and revenues are recognized when earned not when paid or received respectively. This principle is combined with the cash system to create a hybrid that eliminates the majority of their individual limitations (Ittelson, 2009).
The materiality principle emphasizes that all vital matters should be properly disclosed and suggests that those issues that are classified as trivial can be ignored as long as it does not impact greatly on the financial statements.
The Consistency principle stresses the importance of maintaining practices, rules and concepts used in the preparation of financial statements throughout the various accounting periods. This consistency is important in easing the process of comparing the statements (Introduction to accounting, n.d).
The conservatism principle suggests that accountants should prefer the understatement of amounts or profits where doubts are existent. Conservatism is based on playing safe in instances where uncertainties are present, but its excessive use could result in fraudulent practices (Introduction to accounting, n.d).
The Substance over form principle ensures that items are accounted for in terms of their economic reality as opposed to just their form. This principle ensures that a vivid and relevant picture of events as well as transactions is painted thus fostering accuracy (Ittelson, 2009).
These principles are vital because they guide companies when preparing financial statements such that they prove to be objective, relevant to the users and feasible in comparison and SWOT analysis.
References
Accounting Principles: Financial Skills (1st ed., pp. 19-21). Retrieved from http://www.free-
management-ebooks.com
Ittelson, T. R. (2009). Financial statements: A step-by-step guide to understanding and creating
financial reports, revised and expanded edition. Franklin Lakes, N.J: Career Press.
Introduction to accounting (1st ed., pp. 13-16). Retrieved from http://www.b-
u.ac.in/sde_book/bbm_account.pdf
