Accounting concepts and principles are the guidelines being followed in recognition, reporting and presentation of financial information. It is important that we apply standards for accurate and complete reporting. As mentioned, these financial information is needed to make sound business decisions.
1. Business Entity Concept or Economic Entity Concept - It is the principle stating that the business is a distinct entity from its owners. It means that any personal transaction of owners should be separate from the business.
2. Money Measurement Concept – Every transaction that will be recorded can be measured in terms of money.
3. Going Concern – it is an assumption that business has the intention and the capacity to continue its operation and not liquidate for the foreseeable future.
It is assumed that the business is a going concern in the absence of significant information to prove otherwise.
If a company is determined to be not a going concern, assets will have to be valued at net realizable amount or its liquidation value.
4. Cost Principle or the Historical Cost Principle – this principle requires that asset be recorded at their acquisition cost. Valuation of asset other than cost may be used if certain conditions are satisfied to avoid material misstatements in the books.
5. Materiality and Completeness Concept – information that can have an impact on decision making is considered material. Financial statements therefore should be complete in all material information to aid its users.
6. Timeliness – users of financial information should have access to it while it is still relevant to aid them in making decisions. Delay in its availability might impair their role in making sound decisions.
7. Comparability – accounting policies should be consistently applied for the financial statements to be comparable. This concept allows us to compare the financial statements of the same company over different periods of reporting, as well as the comparability of financial statements of different companies under the same industry. Any change in accounting policy should be disclosed.
8. Understandability - presentation of the financial statements can be easily comprehended by people with reasonable knowledge of the business.
9. Verifiability Concept - contents of financial statements must be verifiable to assure that true and fair information is presented to its users.
10. Revenue Recognition Principle – income or earnings should be recorded in the period they are earned. We therefore recognize revenue when we have delivered the goods or perform the services.
When we received an advance payment for services we have not yet rendered, do we recognize and income? No, we defer it and record it as an Unearned Income. We deliver the goods but we have not yet received the payment, do we recognize a revenue? Yes, we record sales revenue and accounts receivable.
11. Matching Principle – an expense must be recorded in the period it is incurred to match recording of the related income in the period it is earned. Understand more about matching principle with this related article.
12. Accrual Concept - Accrual principle is associated with the matching principle where we record the expenses in the period it is incurred. Understand more about accrual accounting with this related article.