9 Commonly Accepted Accounting Principles
By Indeed Editorial Team
Updated 12 August 2022 | Published 6 June 2021
Updated 12 August 2022
Published 6 June 2021
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
The principles of accounting are guidelines that provide the basis for more formal accounting standards and regulations. It determines the rules using which an organisation must prepare its financial documents. When creating accounting records, accountants and bookkeepers should follow these principles to ensure transparency and uniformity.
In this article, we will learn what accounting principles are and understand the different accounting principles used in Indian bookkeeping.
What Are Accounting Principles?
Accounting principles are rules and guidelines that accountants and companies have to follow when reporting their financial statements. These principles help in maintaining uniform and consistent accounts for every company. The Indian Accounting Standard (Ind AS) gives the accounting principles in India.
These accounting principles standardise the accountancy system by ensuring every organisation operating in India is honest and transparent in reporting its financial statements. The principles are highly informative and reduce any confusion related to accounting. This comes in handy during external auditing of organisations. As these audits are a requirement of the creditors, lenders and investors, everyone in the accounting field needs to understand these principles.
Often, these accounting principles are known as Generally Accepted Accounting Principles (GAAP). Also, some accounting principles are industry-specific and may not apply to other organisations. When working in the accountancy field, you must know about general accounting principles and industry-specific principles.
9 Accounting Principles
Here are 9 accounting principles you must know before stepping into the accounting industry:
Monetary unit principle
The monetary unit principle states that all business transactions must be in terms of money and Indian currency (₹). Money is the common unit used for recording business transactions such as capital, assets and liabilities. A business cannot report its assets as three buildings, two machines or one brand name. That is why the monetary unit stresses reporting only those transactions that you can express in monetary terms. However, you may record other types of transactions separately. The principle assumes that the purchasing power of money remains unchanged with time. This principle does not give importance to the concept of inflation.
For example, your organisation purchased a building worth ₹20 lakhs in 2012. Due to inflation, the building costs ₹40 lakhs in 2016. You cannot reflect the same in your accounts as per the monetary unit principle.
Going concern principle
The going principle assumes that a business is likely to continue its activities for an indefinite period. It means that the organisation will not liquidate and will not be dissolved. Because of this principle, accountants can treat some items as assets instead of expenses because the business will operate and reap benefits from the asset in the future as a going concern.
For example, accountants report purchases of machinery as an asset instead of an expense because, as per the going concern principle, the organisation will continue in the foreseeable future. This helps the accountant allocate the cost of the machinery over its useful life.
The going concern principle is beneficial for investors, as it gives assurance that they will receive a return on their investment. The absence of going concern accounting principle will ensure that organisations report their expenses without deferring them.
Dual aspect of the duality principle
The duality principle of accounting suggests that every business should record its transactions in two separate accounts. Each transaction has an equal and opposite impact on the business. This concept is the foundation of double-entry bookkeeping and essential for creating financial reports. The equation of the dual aspect principle is:
Assets = Liabilities + Equity
The principle explains that there will be both a credit and debit for the same amount when a transaction occurs. For example, when organisations purchase computers and laptops through cheques, the accountant considers the transaction's two-fold effect. The credit side is owning machinery and the debit side is the reduction in the bank balance.
This accounting principle helps auditors find out potential loopholes and errors in the financial statements.
The cost principle states that a business should record its assets at the purchase price and not the market price. The purchase price includes the installation and transportation charges.
For example, if an organisation purchases a piece of cosmetic manufacturing machinery for ₹2,00,000 and spends ₹2,000 on installation and ₹800 on transportation, the machinery's purchase price would be ₹2,02,800. If the same machinery's current market price is ₹5,00,000, the accounting books will still reflect ₹2,02,800 as the purchase price.
As the cost principle deals with cost in the past, the purchase price is known as the historical cost. So, the cost principle implies that if organisations pay nothing for acquiring the assets, they cannot include the asset in their financial statement. For this reason, goodwill appears in the financial statements only when organisations pay the price for this intangible asset.
The realisation principle states that a business should record the revenue from any business transaction only when realised. According to this principle, a business earns revenue when the organisation gives its goods and services to a customer through cash or some asset in exchange. In short, the realisation accounting principle states that revenue is realised when a business earns it and not when it collects the revenue.
For example, a SaaS company receives an order for supplying software worth ₹4,00,000. The company supplies SaaS software worth ₹1,00,000 by 31st December 2021 and the rest of the order they supply in January 2021. The 2020 revenue for the SaaS company would be ₹1,00,000 because merely getting an order is not revenue until the goods or services reach the customer.
One of the essential principles of accounting is the accrual principle. It states that a business must record the transactions during the accounting period in which they occur, irrespective of when the business receives the cash flow for the transaction. In short, a business must record the accrued income in the period in which it arises rather than the subsequent period in which the business will receive the income. Similarly, a business must record the accrued expenses in the accounting period in which it occurs rather than the period in which the business receives the payment.
Furthermore, this accounting principle advocates that a business must show all the prepaid expenses in the accounting period in which the business pays for it. The accrual accounting principle is essential because it ensures that expenses match the revenue in an accounting period.
For example, utility companies in India usually bill customers once a month for their service, whether it is electricity, water or gas. The company's accountant records the revenue when it bills the customer at the end of the month, even though the customer will submit the payment in the subsequent month.
The matching principle directs that a business should report expenses on the income statement for the accounting period in which the business earned its related revenue. So, once the revenue becomes receivable, the business should allocate it to an appropriate accounting period with the accrual principle's help. If the business postpones the revenue to the next accounting period due to some circumstances, it should postpone the expenses to that accounting period.
For example, if a jewellery store spends ₹1,80,000 on social media marketing in 2018 with marketing strategies likely to benefit three accounting periods, 2018, 2019 and 2020, then in such a case, only ₹60,000 is an expense incurred in 2018. The accountant will report the remaining amount in 2019 and 2020.
Applying the consistency principle would mean that once a business adopts an accounting principle or method, they must follow this method or principle for all their accounting periods until an alternative method or principle comes into the market.
The consistency principle is beneficial for auditors, as it helps in comparing financial results from different accounting periods. Maintaining consistency in bookkeeping is imperative to avoid confusion and give insight into how a business reports specific numbers and information on its financial statement. For example, if a retail store uses the last-in, first-out (LIFO) method for reporting financial statements of 2018, they cannot switch to the first-in, first-out (FIFO) method in 2019.
Full disclosure principle
Applying the full disclosure principle means that accountants include all the relevant and necessary information in the financial statements. The information could be how a business maintains the financial records and how the business operates. This principle ensures that users, investors, creditors and readers of the financial information receive no misleading information. A business should include all necessary details like disclosing the accounting method and non-monetary transactions, among other information.
Please note that none of the companies, institutions or organisations mentioned in this article are affiliated with Indeed.
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