Business Courses/Accounting 101: Financial AccountingCourse
- AuthorShawn Custer
Shawn Custer has taught college-level English, composition, and literature for over eight years. She has a Master’s in English and Creative Writing from Southern New Hampshire University and a Bachelor's in English from Thomas Edison State University.
View bio - InstructorRebekiah Hill
Rebekiah received her BBA from Georgia Southwestern State University and her MSM from Troy University. She has experience teaching math to middle school students as well as teaching accounting at the college level. She has a combined total of twelve years of experience working in the accounting and finance fields.
View bio - Expert ContributorSteven Scalia
Steven completed a Graduate Degree is Chartered Accountancy at Concordia University. He has performed as Teacher's Assistant and Assistant Lecturer in University.
View bio
Learn about accounting principles according to GAAP and IFRS. Examine the accounting principles definition, and identify who sets fundamental accounting principles.Updated: 11/21/2023
Table of Contents
- What are Accounting Principles?
- Who Sets Basic Accounting Principles?
- Why are Fundamental Accounting Principles Important?
- Lesson Summary
- FAQs
- Activities
Fundamental Principles of Accounting - A Practical Exercise:
The following exercise is designed to help students apply their knowledge of the fundamental principles of accounting in a real-life context.
Scenario:
You are a consultant that specialized in financial reporting. Your new client, Clumsy Dolls, is a company that just opened shop last month and produces hand-made dolls. Clumsy's founder, Jane, is not all that organized. She confesses that she believes to have made a ton of mistakes with the company's accounting in the first month. She provides you with a list of issues below.
| No. | Issue |
|---|---|
| 1 | Jane decided to use her personal checking account for the company's first inventory purchases. |
| 2 | Jane did not keep any receipts for her first sales because "that's just the past." |
| 3 | Jane is running out of money and is not sure for how long Clumsy Dolls will be around. |
| 4 | Jane doesn't like counting money, so she counted her revenue in dolls (e.g., 10 dolls sold in the first month). |
| 5 | Jane recorded revenue when she received a deposit from a client before having even made the dolls. |
| 6 | Jane's brother recently gave the company a $1,000 emergency loan but did not charge interest to his sister. |
Required:
For each of these accounting issues, determine which of the following fundamental principles are most relevant.
| Terms |
|---|
| Objectivity |
| Arm's length transactions |
| Going Concern |
| Monetary Measurement Concept |
| Revenue recognition |
| Separate entity principle |
Solution:
See below.
| No. | Term |
|---|---|
| 1 | Separate entity principle |
| 2 | Objectivity |
| 3 | Going Concern |
| 4 | Monetary Measurement Concept |
| 5 | Revenue recognition |
| 6 | Arm's length transactions |
What are some fundamental accounting principles?
There are 10 Generally Accepted Accounting Principles (GAAP) as set by the Financial Accounting Standards Board. These includes the principles of regularity, consistency, sincerity, permanence of methods, non-compensation, prudence, continuity, periodicity, materiality, and utmost good faith.
Why do accounting principles matter?
Accounting principles serve several purposes. They ensure that all publicly-traded companies are reporting their transactions and data in the same way so the information can be compared accurately between companies. The principles also serve to protect the public by providing transparency and accuracy in financial reporting.
Table of Contents
- What are Accounting Principles?
- Who Sets Basic Accounting Principles?
- Why are Fundamental Accounting Principles Important?
- Lesson Summary
Accounting principles are defined as the various guidelines and rules that companies must follow when documenting, recording, and reporting financial transactions and information. These rules help to ensure uniformity and accuracy in reporting and analyzing financial data. Having companies record and report their financial data using the same standards allows for the accurate comparison and analysis of data and information. It allows investors to gain an accurate picture of a company's financial health, and it allows for transparency in identifying fraud and inaccuracies in the data.
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There are two primary systems of accounting principles. The United States uses an accounting system known as Generally Accepted Accounting Principles (GAAP), which is established and overseen by the Financial Accounting Standards Board (FASB). On an international scale, the standards and rules, known as the International Financial Reporting Standards (IFRS), are set by the International Accounting Standards Board (IASB).
There are several basic accounting principles set by the IASB that are common to most accounting standards models:
- Objectivity- the concept that all recorded data must be based on documented information, rather than on anticipated transactions, interpretations, or assumed outcomes
- Arm's-length transactions- this concept dictates that parties to a transaction are unrelated to one another
- Going concern- this concept assumes that the business entities in the transaction will remain in business and are not subject to close in the foreseeable future
- Monetary measurement- this concept states that accounting transactions must be recorded in terms of money (dollars and cents in the United States)
- Revenue recognition- this concept dictates that revenue should be recorded when it is earned rather than when payment is actually received
- Separate entities- this principle states that all business transactions must be recorded separately from any private tractions of the business owners or principals
Generally Accepted Accounting Principles
In addition to the common accounting standards, there are 10 key GAAP principles that must be followed by all publicly-traded companies in the United States. Specific GAAP-compliant reports must be filed and certified by the officers of the company in order for the company to be listed on the stock exchange. These principles include:
- Principle of Regularity- adherence to GAAP rules and procedures is standard
- Principle of Consistency- accountants will adhere to the same set of standards throughout all business recordings
- Principle of Sincerity- transaction recordings are accurate and impartial
- Principle of Permanence of Methods- methods of recording and analysis will not be changed from one term to the next
- Principle of Non-Compensation- all transactions will be recorded without compensation for debts
- Principle of Prudence- transactions will be recorded based on facts rather than speculation
- Principle of Continuity- this principle assumes the business will remain in operation
- Principle of Periodicity- transactions will be recorded in their appropriate accounting time periods
- Principle of Materiality- all financial data will be fully disclosed in appropriate reports
- Principle of Utmost Good Faith- all parties will remain honest in all transactions
While not required, many privately-held companies and nonprofit organizations also abide by these standards. Some lenders may require the implementation of the GAAP standards in order to loan money to a company, for example, or investors may require these accounting principles to be in use before they will invest money in a nonprofit, so it benefits privately-held companies and nonprofits to comply.
IFRS Accounting Principles
The International Financial Reporting Standards (IFRS) are the key accounting principles that are applied worldwide. The IFRS includes mandatory rules for accounting that must be applied to the following reports:
- Statement of Financial Position- this refers to the balance sheet used by the company and the specific information and procedures that must be included and followed, according to the IFRS
- Statement of Comprehensive Income- this is a standardized statement showing the income earned by a company
- Statement of Changes in Equity- this document shows the changes to the company's financial standing from one period to the next
- Statement of Cash Flows- a summary report that shows the company's cash flow for a set period
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