Basic accounting principles and rules govern the field of financial accounting. On these, more in-depth and specific accounting laws are based. Here, we look at the main accounting rules that companies must follow when talking about financial accounting data.
There are general laws and concepts that control the field of accounting. These generic rules are the fundamental accounting principles and laws. It is on which more detailed and particular accounting rules are made. Accounting principles are the laws and guidelines that firms must follow when reporting financial accounting data.
Economic Entity Assumption Comprehensive guide
The accountant keeps all of the financial transactions of a sole owner separate from the company owner’s personal transactions. For legal reasons, a solely held company and its owner are considered to be one and the same. However, for accounting purposes, they are thought to be two separate entities.
Time Period Assumption for financial accounting
This accounting principle believes that it is possible to report the complex and continuous activities of a company in relatively short, distinct time gaps, such as the five months that ended May 31, 2023, or the five weeks that ended May 1, 2023. The shorter the time interval, the more probable the need for the person to estimate amounts relevant to the said period. You will receive your property tax bills on December 20th every year. Please note that for the financial year ending December 31, 2023, an estimate is required for the three months ending March 31, 2023. Remember to include the time interval in the heading of each income statement. It is not enough to label them with just “December 31.” The reader needs to know if the statement covers the week, month, three months, or year ending December 31, 2023.
Cost Principle and UK standards
From an accountant’s point of view, the word cost refers to the money spent (cash or the cash equivalent) when a good or service was originally obtained. It does not matter whether that purchase happened last month or thirty years ago. For this reason, the amounts shown on financial accounting statements are referred to as past cost amounts. Because of this accounting rule, asset amounts are never adjusted upward for inflation. In fact, as a general law, asset amounts are never adjusted to reflect any type of rise in value. Hence, an asset amount does not show the amount of money a company would get if it were to sell the asset at its current market value. (An exception is certain investments in shares and bonds that are actively bought and sold on a stock exchange).
Financial Accounting Full Disclosure Principle
Financial statements and notes must disclose crucial information for investors or banks. Companies attach numerous footnotes to their accounting statements to ensure full disclosure. For instance, if a firm faces a significant lawsuit, the records must describe the case. It is not clear if the company will win or lose the case, and this uncertainty demands transparency in financial reporting.
Going Concern Principle comprehensive guide
This accounting principle assumes that a company will continue to exist long enough to carry out its purpose and commitments and will not liquidate in the foreseeable future. If the company’s financial accounting situation is such that the accountant thinks the company will not be able to continue, the accountant is supposed to disclose this assessment. The going concern rule allows the company to kick some of its prepaid expenses down the road until future accounting periods.
UK Standards and Matching Principle
This accounting principle demands companies utilize the accrual rule of accounting. Expenses must match corresponding sales according to the matching principle. Companies should report sales commission expenses when they make sales instead of when they give commissions. Employee wages are considered an expense in the week when employees work, not when they receive their payment. If a company promises to give its employees a bonus of 1% of its 2023 revenues on January 15, 2024, the company must report the bonus as an expense in 2023 and the unpaid amount on December 31, 2023, as a liability. However, accountants cannot match future economic benefits like marketing with related future sales, so they charge the marketing amount to expense at the time the ad runs.
Revenue Recognition Principle
When a product is sold or a service is rendered under the accrual basis of accounting, the company recognizes revenue regardless of when payment is received. For instance, if ABC Consulting provides a service worth €2,000, it recognizes €2,000 of revenue as soon as the work is carried out, regardless of whether the client pays immediately or in 60 days. Do not confuse sales with a cash receipt!
Accountants may violate an accounting law if they consider the amount insignificant. They need to exercise professional judgment to determine if the amount is immaterial. For example, a highly profitable business can expense the full cost of a €300 printer in the year of purchase, breaking the matching principle due to materiality. Financial accounting statements typically round off to the nearest pound.
Conservatism in UK standards
If a situation comes up where there are two or more acceptable alternatives for reporting an expense. It is then conservatism directs the accounting professional to choose the alternative that will cause less net income and/or lower asset amount. The basic accounting rule of conservatism leads professionals to anticipate or reveal losses. However, it does not allow a similar thing for gains. For instance, potential losses from lawsuits will be reported on the financial accounting statements or in the notes. However, potential gains will not be noted. Also, an accountant may note inventory down to a sum that is lower than the initial cost. However, it will not write inventory up to an amount higher than the original cost. Conservatism is defined as the asymmetric recognition of losses over profits. This is due to the immediate expense of some costs as they incu. While gains recognition is deferred until they are realized.