5 Important Concepts to Understand About Accounting

All businesses whether the ones that manufacture industrial equipment, sell a widget, tending to animals, or provide cleaning services operate under the same accounting principles. The accounting principles became commonplace in the early 1800s and are now viewed as generally accepted accounting practices. However, the original concepts of accountancy are dated back to the period of Mesopotamia. Following the formation of bookkeeping treaties in the 1490s, the accounting space has taken significant strides. The following are the fundamental doctrines that form the foundation of the world of accounting.

The Expense Principle

It refers to a point where a bookkeeper or accountant may decide to log a transaction as an expense in the financial statements. Also known as the expense recognition principle, the expense accounting concept states that a business can incur a cost at the time in which it has accepted services or products from another entity. In short, this accounting concept means that a company incurs an expense when it performs any function or delivers a product regardless of when it pays for the transaction or receive payment.

The Revenue Principle

It refers to a situation where an accountant may record a transaction as revenue on financial statements. It states that a business should record all its earnings at the point of sale. The principle means that industry generates revenue at the time it performs a service or a buyer takes legal possession of a sold product as well as the moment at which the seller accepts cash for the transaction. People in the business field sometimes refer to this concept as the revenue recognition principle. It means that businesses should only recognize revenue only after completing the earning process sustainably. Unfortunately, rogue accountants continue to skirt around the fringes of the revenue recognition principle to commit a financial or reporting fraud. As a result, accounting standard-setting bodies around the world continue to research aspects that constitute proper recognition of revenue. 

Matching Principle

It means that businesses should record all their related expenses at the same time after recording their revenue. Thus, entrepreneurs should charge inventory to their sold goods at the same time that they record revenue generated after the sale of those inventory items. The matching principle is the cornerstone of the accounting accrual basis. However, it doesn’t apply to the accounting cash basis. 

The Going Concern Principle

It assumes that an entity will remain the same despite changes in market forces. That means nothing will force an enterprise to liquidate its assets or halt its operations due to low fire-sale prices. The assumption makes an accountant justified to defer the recognition of some expenses until the next financial year. By assuming the absence of all this significant information, an entity is considered to be a going concern. The principle applies when a business can’t meet its obligations due to debt restructurings and substantial asset sales. If this wasn’t the case, then an entity would be acquiring assets for resale or closing its operations. The principle of going concern is, however, not defined anywhere in GAAPs, and so it isn’t clear when entities should report it. However, GAAS instruct bookkeepers and accountants regarding when a business should be allowed to continue as a going concern. 

Conservatism Principle

It states that entities should record their liabilities and expenses as soon as they occur, but record assets and revenues only if they are sure they will happen. It allows conservation of any financial statement that may yield profits since recognition of assets and income may sometimes delay. It encourages accountants to record losses earlier instead of later. Conservatism principle applies where an entity misstates its results persistently to make the situation worse than it is. Accountants can also use the conservatism principle for estimates recognition. The conservatism concept is the foundation for the market rule or lower of cost, a doctrine that states that accountants should record their inventory at the lower of either its current market value or acquisition cost. It runs counter to the taxing authorities needs since the reported taxable income always tends to be lower when an accountant employs this accounting concept. The ultimate result is less stated income, which translates to lower tax receipts.

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