Section: 10 Accounting Principles

Accounting principles are an integral part of the conceptual framework. There are four basic principles of accounting that guide recording of transactions.

Historical Cost: Generally accepted accounting principles require all transactions to be accounted for acquisition cost or purchase cost. This is often referred to as the historical cost principle. This is a practical way of treating transactions as it minimizes confusions that could arise otherwise. If we select current selling price as the basis for accounting, it would be a waste of time and money to find current market prices for all assets and liabilities, for some of them we wouldn't be able to get a price. There would be differing views on prices among people. Further, most companies prepare monthly accounts, this means every month they have to update sales value of assets and liabilities which is a very tedious task. Similar problems would be encountered in other basis of costing of recording transactions.

Matching Principle: Also referred to as accrual concept, this principle recognizes revenues and expenses that made its contribution to earn revenue in computing income for a period. In other words, expenses are matched with revenue on the basis that expense is incurred to realize revenue. Thus, expense recognition is tied to revenue recognition. This practice is referred to as the matching principle because it instructs that efforts i.e. expenses be matched with accomplishment i.e. revenues whenever it is reasonable and practical to do so. In instances where it is not possible to establish a link between revenue and expense, the accountants are expected to follow a rational and systematic allocation policy that is in line with the matching principle. Long life assets are depreciated over its economic life so that the contribution extended by the assets to generate revenue is spread out.

Revenue Recognition: According to this principle the most prudent outlook must be taken when recognizing profits and losses. Revenues are recognized when they are realized or realizable and earned. Revenues are considered to be realized when products are exchanged for cash or claims to cash.

Consistency Principle: The treatment of transactions should be consistent year to year, where there are options available. The primary reason for the importance of the consistency principle is that the accounts will not be comparable across years if varying policies/bases are adopted and users may be misled. Further more, alternate policies and bases will have monetary impact that can manipulate the income.

Full Disclosure Principle: Disclosure of information within financial statements in order to provide a clear picture of the performance and financial position of the reporting entity. When deciding what information to report, accountants follow the general practice of providing information that is sufficient and important to influence the judgment and decisions of an informed user. The information could be detailed in the financial statements itself or in the form of a note or as a supplementary information. The presentation of information to users is fairly settled over the years. There are agreed upon formats with slight variations that are used in practice among companies. It is interesting to note that companies are providing variety of quantitative and qualitative information to the users.