12 Accounting Principals

As business owners, it is important to understand accounting principals to have better communication with an accountant. The Financial Accounting Standards Board (FASB) set up Generally Accepted Accounting Principals (GAAP). Companies in the United States must prepare fiscal reports to the GAAP. These rules tell accountants what financial items to measure, when and how to measure them.

Principal #1: Accounting Entity
Treat owners as separate from their business entity.

Principal #2: Going Concern
Must assume the life of a business is never-ending.

Principal #3: Measurement
Only record and report transactions that are measurable. Parties involved must agree on a value to be recorded.

Principal #4: Units of Measure
Domestic currency is the unit of measure. Companies in the United States must use U.S. dollars as the unit of measure. If a U.S company has operations in a foreign country, the company must report the transactions in U.S. dollars using the most current exchange rate at the time of transaction.

Principal #5: Historical Cost
Fixed assets are recorded and reported at the original transaction cost. For example, XYZ Company purchases a building for $500,000. In 10 years the building is worth $1,000,000. Can XYZ report building asset at $1,000,000 on their balance sheet? The answer is no. They must report the original transaction cost of $500,000. This simplifies accounting and eliminates appraising every year.

Principal #6: Materiality
States all transactions must be reported if it affects the financial condition of the company.

Principal #7: Estimates and Judgments
Giving it your best guess is allowed in situations were complexity and uncertainty make measurements less than exact. It is ok to guess when the expected error will have a small impact and that is the best you can do.

Principal #8: Consistency
Must use the same reporting method over time. Some transactions can be accounted for differently and still be ok. The business entity or accountant must choose a method and stick with it from one fiscal period to another.

Principal #9: Conservatism
Always be conservative in financial reporting. Show losses when you feel there is a great probability of occurring. Not later when it actually does occur. On the other hand, record gains when it actually occurs.

Principal #10: Periodicity
Divide the life of a business into periods of time for which profits and losses can be reported. Time periods are generally, monthly, quarterly and annually.

Principal #11: Substance Over Form
Report the economic substance rather than the form. If it is a duck…then report it as a duck. For example an equipment lease that is really a purchase should be recorded as a purchase.

Principal #12: Accrual Basis
Gives provisions to report income or loss for work that has been completed but not yet paid. Simply permits a business to record a sale as income before getting paid. Once the order ships it becomes a sale. Like wise a company can also report expenses that have not yet been paid.

In summary these are the twelve basic accounting principals that guide financial reporting. With out these rules, comparisons between businesses would be extremely difficult.

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