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Accounting Principles

by PALAK AMBASTHA

Pages 4 and 5 of 37

Chapter Details
1. Accounting Principles

2. Cost Concept

3. Consistency Concept

4. Monetary Unit Concern
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Chapter 1: Accounting Principles
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What are Accounting Principles?
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Generally Accepted Accounting Principles
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Accounting principles are the basic concepts and guidelines that underlie the preparation of financial statements. They provide a framework for recording, classifying, and summarizing financial transactions in a consistent and reliable manner.
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In the United States, commercial businesses and NPOs must adhere to the same accounting standards known as generally accepted accounting principles (GAAP).
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Specialists can analyze the financial data by establishing these guidelines and standardizing accounting practices. These guidelines improve the caliber of the financial data that businesses disclose.
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The Financial Accounting Foundation selects the members of the Financial Accounting Standards Board (FASB), an impartial nonprofit body that sets many of these guidelines.
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Chapter 1: Accounting Principles
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Who determines Accounting Principles?
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Basic Accounting Principles
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Setting accounting standards is the responsibility of several organisations. The Financial Accounting Standards Board (FASB) oversees generally accepted accounting principles (GAAP) in the United States (FASB). The International Accounting Standards Board (IASB) creates International Financial Reporting Standards (IFRS) for use in Europe and other regions (IASB).
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International Financial Reporting Standards (IFRS)
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International Financial Reporting Standards are published by the International Accounting Standards Board (IASB) (IFRS). More than 120 nations, including those in the European Union, utilise these standards (EU).
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To ensuring that a business's financial statements are comprehensive, consistent, and comparable is the ultimate purpose of any set of accounting standards. As a result, it is simpler for investors to examine and glean valuable information from the firm's financial statements, such as historical pattern data.
Accrual
Cost
The accrual principle states that revenue and expenses should be recognized in the financial statements in the period in which they are earned or incurred, regardless of when payment is received or made.
The cost principle states that assets should be recorded at their original cost, and not at their current market value.
Matching
The matching principle requires that a business recognize expenses in the same period as the related revenue, so as to accurately show the results of its operations.
Economic entity
Conservatism
Materiality
The conservatism principle requires that a business should report expenses and liabilities as soon as they are probable, and to report revenues and assets only when they are certain.
The economic entity principle states that a business should keep its financial records separate from the records of its owners or other businesses.
Full disclosure
The materiality principle states that a business should consider the size and nature of an item when determining whether it is important enough to be disclosed in its financial statements.
Consistency
The consistency principle requires that a business use the same accounting methods from one period to another, so that financial statements are comparable over time.
The full disclosure principle requires that a business provide all relevant information necessary for understanding its financial statements, including any potential liabilities or risks.
Monetary unit
Going concern
The going concern principle assumes that a business will continue to operate for the foreseeable future, and therefore its assets and liabilities should be recorded on the basis of this assumption
The monetary unit principle states that a business should only record transactions that can be expressed in terms of a stable and common currency.
Matching
The matching principle requires that a business recognize expenses in the same period as the related revenue, so as to accurately show the results of its operations.
Reliability
Materiality
The materiality principle states that a business should consider the size and nature of an item when determining whether it is important enough to be disclosed in its financial statements.
The reliability principle requires that a business's financial information should be accurate, verifiable, and trustworthy, based on reliable data and methods.
Revenue recognition
Monetary unit
The monetary unit principle states that a business should only record transactions that can be expressed in terms of a stable and common currency.
Time period
The revenue recognition principle states that revenue should be recognized in the financial statements when it has been earned and can be reliably measured.
The time period principle states that a business should prepare its financial statements over regular and uniform time intervals, such as months or years, to provide a basis for comparison.
Chapter 2: Cost Concept
What is cost concept?
As we have discussed about accounting principles and 13 basic concepts of accounting in the previous chapter, you must be wondering what are these concepts and how are they applied in real time scenarios.

Let us understand the cost concept in depth.
Cost concept is based on the idea that historical cost is a more objective and stable measure of an asset's value compared to its market value, which can fluctuate over time.
The cost concept in accounting is a principle that determines how assets should be valued and recorded in a company's financial statements. It states that assets should be recorded at the amount of money spent to acquire them, known as their "historical cost." This cost should include all expenses incurred in order to bring the asset to its intended use, such as transportation costs, installation fees, and any necessary modifications.
The cost concept is closely tied to the historical cost principle, which states that assets should be recorded at their original cost in the financial statements and not adjusted for inflation or market value. This principle provides a basis for consistent and comparable financial reporting over time. By valuing assets at their historical cost, companies can accurately track the changes in the value of their assets over time and report these changes in their financial statements.
Chapter 2: Cost Concept
Advantages of Cost Concept
Comparison: The cost principle provides a basis for comparing the financial performance of different companies, as it allows for consistent reporting of assets over time.

Decision Making: By providing a clear and consistent measure of an asset's value, the cost principle can be useful for decision making and budgeting.
Objectivity: By recording assets at their historical cost, the cost principle provides a more objective and stable measure of an asset's value compared to other methods.

Consistency: The cost principle allows companies to consistently value assets over time, which helps ensure that financial statements are comparable from one period to another.

Simplicity: The cost principle is relatively straightforward and easy to apply, making it a useful tool for accountants and financial analysts.
Reduced Complexity: The cost principle helps to reduce the complexity of financial reporting by providing a clear and consistent method for valuing assets.
Objectivity
Creates reliability and comparability of statements, which helps build confidence in the financial information for investors, regulators, and other stakeholders.
The historical cost concept refers to documented values that are accurate and verifiable, such as receipts, bank transactions, or invoices, and which may be used to quickly determine the original worth of an item at acquisition.
Lack of Relevance: The cost principle values assets based on their historical cost, which may not reflect their current market value. This can make the information reported in financial statements less relevant to stakeholders who are interested in the current value of assets.

Inflation: The cost principle does not adjust for inflation, which can make the values of assets reported in financial statements appear lower over time. This can make it difficult to accurately assess the real value of assets and the financial performance of a company.

Depreciation: The cost principle does not take into account the impact of depreciation, which can cause assets to lose value over time. This can result in a mismatch between the value of assets reported in financial statements and their true economic value.

Disadvantages of Cost Concept
Market Fluctuations: The cost principle does not take into account changes in the market value of assets, which can result in significant differences between the values reported in financial statements and the actual values of assets.

Complexity: The cost principle can be complex to apply in certain situations, such as when valuing intangible assets or when considering the impact of inflation on the cost of an asset.
Ease of Record Keeping
It can be considerably simpler to keep track of this original value because the cost concept just considers an asset's initial purchase price. This is because a corporation may not need to frequently upgrade its financial information to indicate current market values since the historic cost principle just requires the starting cost of an item.
A company purchases a piece of equipment for $100,000. The historical cost of the equipment is recorded in the company's financial records as $100,000.

If the market value of the equipment increases to $120,000, the cost principle would still value the equipment at $100,000 in the company's financial statements, as the cost principle only records assets at their original cost.

If the company sells the equipment for $120,000, the company would recognize a gain of $20,000 in its financial statements. The cost principle would not affect the recognition of the gain, as it only applies to the initial valuation of assets and not to changes in their value over time.

This example shows how the cost principle provides a basis for consistent and objective valuation of assets in financial statements, while also allowing for recognition of changes in value over time.
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