Accounting Principles

Accounting Principles

Important principles of accounting are accrual, consistency, Going concern, faithful presentation, matching, Historical cost etc. These principles have been briefly explained below

1.    Accrual Principle

Accrual is an important accounting principle. Under accrual principle transactions are recorded in the period to which they relate (expenses and income is recorded in period to which these relate). It means occurrence of economic event/benefit is the most important factor for recording of transaction.

The recording of transaction must not be confused with cash payment or receipt. Accrual concept has fundamental importance for accuracy of financial statements. Matching concept can be effectively applied, where accrual system is working. Some examples of accrual concept are as under

Services received but not paid during the yeas should be recorded as current year expense irrespective of payment status of salaries. Similarly unpaid repair made during the Year shall be recorded as current year expense.

2.    Consistency Principle

Consistency is another important accounting principle. Consistency principle requires consistent presentation of items in the financial statement. Thus presentation should not be changed from one period to another.

Consistency Principle also requires continuity in accounting policies applied for the preparation of financial statements. Consistency principle ensures the comparability of financial statements. However, under following circumstance change in presentation is allowed

1.    Required by an international accounting standard.

2.    If Change improves user understanding.

Example of consistency

Particulars	2016	2015
Salaries & Allowances	40,000
Basic Salaries		25,000
Allowances		3,000

In above example, it is shown that salary presentation has been changed in 2016. Now salary is difficult to compare. Salary has increase in current year, but it is not clear that such increase is in basic salary or in allowances

3.    Faith-full presentation

Faith full presentation is another important accounting principle. Financial statement should give true picture of financial affair of the entity. Faith full presentation may be achieved by the application of following principles.

1.    Financial statement should be complete (all material transaction are reflected)

2.    Accounting policies applied should be free from management biased.

It is to be noted that faithful presentation is a time consuming and costly job.  Therefore balanced approached is required to achieve Faith-full presentation and cost for achieving faithful presentation should not exceed value of faithful presentation.

4.    Materiality Principle

Materiality is an important accounting principle. Under Materiality principle all material information should be reflected in the financial statement. There are two important factors for determining the materially of an item of financial statement i.e. size and nature of item. These both factors may be important individually or collectively for deciding Materiality of an item. Materiality concept has been explained with simple example

1.    Entertainment expenditure (material due to nature)

2.    1 million Electricity (total operating expenditure is 2 million- material due to size)

5.    Prudence Principle

Prudence is also an important accounting principle. This principle or concept has important role during the estimation process.  Prudence concept does not support any optimism (favorable reflection of financial statement).

Prudence concept requires a cautious approach toward preparation of financial statement. Prudence concept says that asset and income should not be overstated; similarly liability and expense should not be understated. Prudence concept is more relevant in deciding the provision of doubtful debt etc.

6.    Substance Over Form Principle

Substance over form is one of the most important accounting principles. This principle requires that transaction are recorded in the books of account on the bases of economic reality is more relevant than legal reality. In other word if legal form is different from the economic reality, then economic reality should be preferred. Famous example of substance over form is

1.    Financial Lease is recognized as asset (Despite ownership is not transferred)

2.    Sales and buy back ( recognized as a loan)

7.    Historical Cost Principle

Another important accounting principle or concept is historical cost. It means transaction must be recorded in the book of account on actual cost, this concept is more relevant for initial recognition, because now a days fair value recognition is also applied for some transaction recognition & reporting.(Especially at balance sheet date).

8.    Going Concern Principle

Going concern is a fundamental accounting principle .it means that Business will continue to exist for a long period at least for 12 months and accounts are prepared on the bases of this assumption. If this assumption is not valid, then financial statement are prepared using different bases.