Basic Accounting Principles
Having knowing a little facts from accounting history let us now try to know what are some basic accounting principles .These are:
1. Accrual principle.
*accountingexplained.com/financial/principles/accrual
3. Full disclosure principle.
4. Matching principle.
- is the most fundamental principle of accounting which requires recording revenues when they are earned and not when they are received in cash, and recording expenses when they are incurred and not when they are paid.
Example:
- An accounting firm obtained its office on rent and paid $120,000 on January 1 as annual rent. It does not record the payment as an expense because the building is not yet used. Instead it records the cash payment as prepaid rent (which is a current asset):
| Prepaid rent | DEF | |
| Bank | DEF |
- The firm recognizes rent expense over the period. For example, in preparing its quarterly income statement on March 31, the firm expenses out three months' rent i.e. 30,00 (= $120,000/12 × 3] because 3 months equivalent of time has expired (from 1 January till 31 March).
| Rent expense | GHI | |
| Prepaid rent | GHI |
*accountingexplained.com/financial/principles/accrual
2. Cost principle.
- It is also known as the historical cost principle. The cost principle requires that assets be recorded at the cash amount (or its equivalent) at the time that an asset is acquired.
- If equipment is acquired for the cash amount of $50,000, the equipment will be recorded at $50,000. If the equipment will be useful for 10 years with no salvage value, the straight-line depreciation expense will be $5,000 per year (cost of $50,000 divided by 10 years). The equipment's market value, replacement cost or inflation-adjusted cost will not affect the annual depreciation expense of $5,000
3. Full disclosure principle.
- The full disclosure principle states that you should include in an entity's financial statements all information that would affect a reader's understanding of those statements. It requires that all material information has to be disclosed in the financial statements either on the face of the financial statements or in the notes to the financial statements
- Accounting policies need to be disclosed because they help understand the basis of accounting.
- Details of contingent liabilities, contingent assets, legal proceedings, etc. are also relevant to the decision making of users and hence need to be disclosed.
- Significant events occurring after the date of the financial statements but before the issue of financial statements (i.e. events after the balance sheet date) need to be disclosed.
- Details of property, plant and equipment cannot be presented on the face of the balance sheet, but a detailed schedule outlining movement in cost and accumulated depreciation should be presented in the notes.
4. Matching principle.
- The matching principle states that expenses should be recognized and recorded when those expenses can be matched with the revenues those expenses helped to generate. In other words, expenses shouldn't be recorded when they are paid. ... Period costs do not have corresponding revenues.
- -Angle Machining, Inc. buys a new piece of equipment for $100,000 in 2015. This machine has a useful life of 10 years. This means that the machine will produce products for at least 10 years into the future. According to the matching principle, the machine cost should be matched with the revenues it creates. Thus, the machine is depreciated over its 10-year useful life instead of being fully expensed in 2015.
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