Fundamental accounting principles are a set of guidelines that govern a company’s accounting process. To ensure consistency and accountability, all accountants must adhere to these standards while doing their duties. Certain countries adhere to particular standards, but some laws also follow global standards.
When you practice accounting, you must have a basic grasp of these main accounting concepts. However, it isn’t easy to remember and may vary according to your region. That’s why choosing accounting software for financial services is the best bet for conducting a seamless accounting process.
Let’s dive deeper into this topic and discover the basic accounting principles to consider.
What are the Principles of Accounting?
Principles of accounting refers to the rules that should be followed when it comes to drafting financial statements, which are later shared with stakeholders or lenders of the company. It includes the cost principle, matching principle, revenue recognition, and many more.
These accounting principles direct accountants while making income statements or any other financial statements. Sometimes also known as generally accepted accounting principles (GAAP), these principles highlight the guidelines applicable to different topics.
List of Fundamental Principles of Financial Accounting
Here are some of the most widely recognized fundamentals of accounting to use while performing your accounting duties.
1. Accrual Principle
The accrual theory in accounting states that all expenses should be recorded in the amounts they occur no matter when the transaction happened. This theory is especially relevant in accrual accounting since it allows for creating more detailed financial records that demonstrate what changes occurred over time.
So, when you are using online accounting software – you must be aware that to record a transaction, it is not necessary if it is paid in cash or not. If an entity does not adhere to the accrual concept, the resulting cash flow can cause the transaction to be artificially accelerated or delayed.
2. Conservatism Principle
The conservatism philosophy explains that any expenditures and liabilities should be reported as soon as practicable. In contrast, profits and assets should be registered only after an accountant is confident they will arise. As an SME owner, you must check that your software for creating invoices is built on this fundamental or not because expenses are always crucial to a business.
Using this idea will skew financial statements in a conservative direction, resulting in lower estimated earnings due to asset and revenue identification delays.
3. Consistency Principle
The consistency principle is all about adopting one accounting system for your company consistently for accounting practices and preparing financial statements. If the accuracy theory is properly and narrowly followed, there are many advantages for financial statements, which are later shared with stakeholders. That applies to the use of small business financial reporting software. Software that follows the consistency principle will simplify things for you.
4. Cost Principle
It states that a company can report all equity contributions, profits, and liabilities at their initial purchasing prices. This principle says that the quantities reported cannot be modified for market value increases or inflation. The exemption to this rule is whether a short-term transaction in a corporation’s capital stock changed in market valuation. However, this exception only happens if the securities are publicly traded on one international stock market. You need to make sure that accounting software must help you prepare accurate statements.
5. Economic Entity Principle
According to the Economic Entity Principle, a company’s operator has separate legal liabilities. The company must distinguish all purchases from its owners, shareholders, and other businesses. This means that the transactions reported in the entity accounts are just those belonging to the entity.
For example, let us say you own a coffee shop. One day, you take a bag of coffee beans home for personal use. Since this is not related to your business operations, it should not be recorded as a business expense. To maintain accurate records, your billing software must treat the coffee shop as a separate entity.
6. Full Disclosure Principle
The full disclosure principle demands that the company should reveal all necessary information in its financial report. This is to ensure that it gives a magnified view of the company’s financial condition. As a result, it is essential to ensure that they have access to all relevant material using accounting software for financial services. You should obey each accounting requirement regardless of whether the condition that occurs in your entity should be revealed or not.
Financial Reports Now at Your Fingertips
Generate accurate financial reports using Moon Invoice and prepare income statements as quickly as possible.
7. Going Concern Principle
Going concern is the term that assumes the business will continue to run, usually twelve months from the operation date if the financial accounts are compiled based on a going concern. This principle impacts the decision on equipment depreciation or amortization as it considers business will not liquidate its assets no matter what. With the going concern principle, the company is not required to liquidate investments as it assumes they will operate continually.
8. Matching Principle
The matching theory is an accounting principle that governs how costs and receipts are recorded and recognized in financial statements. It ensures that profits and liabilities in the income statement are accurately measured in the timeframe. When this principle is followed correctly, net profits appear in the income statement indeed and equitably, not due to an overestimation or underestimation of sales or expenditures.
9. Materiality Principle
It indicates that important financial details leading to decision-making must be recorded and reported correctly. The materiality principle helps businesses figure out what information should go into their financial statements based on how much it could matter to others. If you record material incorrectly, it will further contribute to the wrong decisions.
For example, if a company spends hefty money on something unusual compared to its regular income, this should be shown separately in the financial report. This way, stakeholders will find it easier to know how it affects the company’s finances.
10. Monetary Unit Principle
You must include transactions only when they can actually be expressed as monetary terms. So, it keeps the records simple and easy to understand by showing everything in a consistent money format. For instance, if the company buys a commercial building, you must record the paid amount instead of mentioning the size and amenities. This is how you should double-check if every record is expressed in currency and not in other terms.
11. Reliability Principle
The reliability principle states that the entered information should be facts and not related to any personal use. This is because to maintain accuracy in the reports and for that, you must have valid proof whenever the financial entry is made. Let’s say you report $3500 as an employee’s meal expense, then you must also attach relevant documents. Likewise, you must follow a similar process if you list out accommodation or transportation costs when generating reports.
12. Revenue Recognition Principle
As its name suggests, revenue should be recorded only when you earn and not when the cash comes in. In other words, the business should record revenue once the delivery of the product is complete no matter whether the amount is paid or not. This accounting practice displays the company’s accurate earnings for a specific period. Assuming you completed furniture delivery in August but got paid in September. As per the revenue recognition principle, you must record revenue generated in August.
13. Time Period Principle
The time period principle states that reports should comprise the exact time in order to maintain comparability. It allows businesses to efficiently manage records in the ledger and simultaneously compare them to gauge their performance. For instance, if your company prepares the financial report starting from April 1st to March 31st, then you must ensure that all expenses incurred during this period are recorded.
Why Is Financial Accounting Important?
Financial accounting is crucial not only to survive tax season but also for various reasons. Below are some reasons why financial accounting matters for your business.
1. Budget Plan
Keeping track of finances means you can identify your cash flows and financial position, helping you create an efficient budget plan for next year. Analyzing accounting metrics you can cut down unnecessary business expenses and make sure you accomplish desired profit goals. Also, it helps you set up competitive prices to ensure your business thrives.
2. Financial Reporting
Businesses need to record accounts payables and accounts receivables to prepare income statements, which can be used to report governing bodies. Therefore, you must ask the accounting team to keep a tab on the cash flow and update the spreadsheet accordingly. Remember your statement should align with the principles of financial accounting or else you might face penalties that further impact your budget plans.
3. Drawing in Investors
Financial accounting is also important to attract investors in order to raise funds for your company, helping you achieve organizational goals. Investors often scan the company’s financial reports before they make an investment. Investors look for the company’s financial health using these reports as they expect high returns on investment (ROI).
Importance of Principles of Accounting
While it may seem difficult to comply with accounting rules, adhering to accounting principles is important for several reasons.
1. Financial Analysis
Companies follow accounting principles to make important statements and determine their net income and expenditure during a fiscal year. This practice is also essential to identify liabilities incurred by the company. By following accounting principles, businesses get a bigger picture of their financial condition and identify if they are on the right track.
2. Cross-comparison
Considering accounting principles helps businesses cross-check their data to know whether it meets the guidelines. The accounting team conducts quick comparisons to ensure compliance with these principles, helping the company avoid potential penalties and maintain regulatory standards. Such financial practices will also aid in impressing investors or lenders.
3. Transparency
Adhering to accounting principles can offer transparency in your accounting process, making it easier to determine red flags and tackle fraudulent activities. It promotes transparency in such a way that you can avoid misunderstandings and improve credibility by offering a clear and accurate financial picture to anyone outside the company.
How Do Accounting Principles Work Under GAAP and IFRS?
Accounting principles under GAAP and IFRS aim to combat irregularities and facilitate data management. They can also be used to discover investment opportunities abroad as accounting principles align with international standards. Here, let’s understand how accounting principles work under GAAP and IFRS in detail.
| GAAP | IFRS |
|---|---|
| It defines at what time revenue can be recorded. | It observes control for the transfer of goods. |
| Specifies when business expenses should be compared with the company’s income. | Outlines the match of expenses with revenue output. |
| GAAP highlights guidelines for recognizing a company’s liabilities. | IFRS offers general guidelines rather than defining rules. |
| It describes the accounting standard for investments. | It prefers the equity method as far as investments are concerned. |
Make the Accounting Process a Breeze With Moon Invoice
Utilize Moon Invoice to manage important accounting & invoicing documents in the cloud to simplify the accounting process.
Conclusion
No matter whether you are doing an accounting process manually or using small business finance reporting software, the Generally Accepted Accounting Principles (GAAP) play a significant role in your business accounting.
Since technological advancements are on the rise, using automated processes for accounting can be more effective than manual processes. It makes the business accounting process smoother and more superficial.
If you are looking to optimize your accounting process, consider getting accounting and invoicing software like Moon Invoice that complies with all the fundamental principles. Start your free trial now.
FAQs
Jayanti Katariya is the founder & CEO of Moon Invoice, with over a decade of experience in developing SaaS products and the fintech industry. He holds a degree in engineering. Since 2011, Jayanti's expertise has helped thousands of businesses, from small startups to large enterprises, streamline invoicing, estimation, and accounting operations. His vision is to deliver top-tier financial solutions globally, ensuring efficient financial management for all business owners.
