Accounting is an art of communicating and reporting the financial information to its users such as Investors, Creditors, Banks and Customers. This purpose can be achieved only if there is a definite set of principles which are accepted and understood by all the parties with mutual consent.
Accounting principles are a general set of rules and guidelines that are set up by a specified board in a country that are followed by the companies for their proper functioning and reporting of their financial statements. The accounting principles make the communication and reliable.
The US Accounting System generally follows the US GAAP i.e. Generally Accepted Accounting Principles. The U.S. Securities and Exchange Commission (SEC) adopts these principles and presents its financial information.
1. Business Entity: The business entity concept states that the business owner and the business are two separate entities. The business is different from the owner and can operate independently. It can buy assets in its own name. The personal expenses and incomes of the owner cannot be added in the books of accounts of the firm or company and vice versa; unless the owner withdraws or deposits money in the business account.
2. Going Concern: The going concern concepts states that the business will be carried on indefinitely. The age of business cannot be predetermined. The business will go on for a foreseeable period. On the basis of this concept the expenses can be deferred for the future period and the expenses can be taken forward. Similarly, the assets are always taken up for an indefinite period and not put up for immediate sale.
3. Monetary Unit: This principle states that in accounting system, only the terms that can be measured or expressed in monetary terms will form a part of the accounts. The qualitative aspects are not covered in the accounting system. It is an easy task to measure a product or service in monetary terms rather than in the qualitative terms. Thus, a purchase price of product can be measured in terms of money but not its quality.
4. Historical Cost: As per this principle the assets are always shown on the price that was paid on its acquisition or the purchase price and not its current market value or realizable value. If such a valuation is done it will violate this principle as well as the Gong Concern principle. But the assets can be valued on the market value or realizable value only in the case the business is being wound up or there is reconstruction or amalgamation or revaluation of the business takes place.
5. Matching: This principle clarifies that when an income is recorded then the related expenses incurred to earn the same income must be recorded at the same time. Thus the identical expenses should be recorded simultaneously to the incomes earned. For e.g. the cost of goods sold is recorded at the same point when the sale/ revenue is recorded.
6. Accounting Period: The life of a business is always divided into small part for timely scrutiny of the accounts and the position of the business. The small parts thus made are referred to as the accounting periods. At the end of each accounting period the position and status of the accounts is checked and reported to the concerned authorities. Generally the accounting period is of 1 year but it may differ like months, quarters and fortnight.
7. Conservatism: This principle is also known as Prudence concept. This principle adopts a narrow approach to the recording of transactions. It states that “Do not anticipate incomes but provide for all losses.” In other words, the estimated incomes must not be recorded but the expected expenses should be recorded beforehand. This prepares the business for any unforeseen contingencies.
8. Consistency: It states that all the business policies and methods of a business should remain consistent. The policies cannot be changed from time to time. These can be changed only if a better policy comes or if the statute requires such a change. The frequent changes in the policies will make it a difficult task to ascertain the position of the business. If there is any change in the policies, it must be stated separately in the balance sheet and the difference between policies must be shown using the practical application.
9. Materiality: This concept states that every detail and information must be recorded properly in the business. It is information that influences the working and decision making of a business. The information that is vital to the business and is of utmost importance must be stated separately and properly.
10. Objectivity: This principle states that the transaction to be recorded in the business must be free from any kind of biasness. There should be proper auditing of the business and a documentary proof must be attached to the transactions to approve it of its authenticity.
11. Accrual: This concept states that the business expenses should be recorded on the basis of their occurrence. They should be recorded in the year of their occurrence and must not be deferred. If an expense is incurred it must be recorded when it is incurred and not when it has been paid for in cash or any other form of payment. Similarly, the incomes must also be recorded on the same basis.
Thus, we see how the accounting principles go on playing a vital role in the proper functioning of the business entities.
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