“For every debit, there’s a corresponding credit”.
You might have heard this phrase a couple of times, and it’s true because it’s very relatable to our everyday lives. Once you receive a credit alert, no doubt, multiple debits will follow.
In this post, I’ll share a very insightful view into the most essential accounting concepts and principles that’ll help you curate better financial statements over time.
What are Accounting Concepts and Principles?
Before we dive right in, let’s review certain terms first.
According to the dictionary, a concept {noun} is an abstract or generic idea. Concepts and Principles are simply guidelines that give users ideas on how to carry out certain tasks.
Now that we have an idea of why principles exist, let’s take a peek at what accounting means. Breaking the word down, we can make out another word, “Account,” which pretty much means a report or description of certain events or experiences.
Accounting is a process of measuring, analyzing, and processing financial data/information about a business or company in order for users to use this information to make informed decisions.
Now with this understanding, we can deduce that accounting concepts and principles are the guidelines that inform how we process and analyze financial information.
So if you’d like to analyze your bank statements, financial statements, and other transactional data, here are the principles you need to use.
The Five Principles of Accounting
There are actually a ton of accounting principles. However, we’ll review the most important five, along with how they work.
1. Accrual Basis
This concept states that our transactions should be recorded when they occur, not when the money changes hands. In other words, we should recognize revenue when it is earned or recognize expenses when we incur them, even if the recipient hasn’t receive it yet.
A clear example is if I visit Mama Sabinus cafeteria to eat lunch, I should recognize that expense in my books even if I do not pay her that same day. Personally, because of this principle, if you promise to send me money, I’ll start my accounts from the day you made the promise.
2. Consistency
This principle requires that businesses and companies need to apply the same accounting methods and principles consistently over time. Consistency allows us to compare the financial statements of different periods of the company’s existence. This makes it easy for anyone to analyze the company’s performance and financial position.
When a company has been consistent with its methods and principles, I can easily pick up its financial statements (FS) and I can deduce which year the company performed better. It’s interesting, right? This is just a tip of what you can enjoy when you have a consistent company financial statement.
3. Going Concern Assumption
The going concern assumption assumes that a business will continue to operate till the end of time. This principle allows us accountants to prepare our financial statements as if the company will continue its operations in the foreseeable future.
Because of this principle, you can always be prepared for a financial audit. It helps show durability and positions the company as a key player in the market.
4. Materiality
This concept relates to the significance of an item in the financial statements. An item is considered material if its omission or misstatement could influence the decisions of users. Material items must be disclosed appropriately in the financial statements.
What this means is that if there is an item that is omitted from a company’s F.S., and this omission leads to a decision I was not supposed to make, if it was not omitted, it means that Item is Material.
5. Prudence (or Conservatism)
Our final principle is prudence. This concept advises accountants to exercise caution when making estimates and to recognize potential losses and expenses rather than potential gains. This helps prevent over-optimism in financial reporting.
The prudence concept also refers to a crucial principle used in accounting to ensure that income and assets are not overstated in financial statements. Alternatively known as the conservatism principle, it also makes sure that liabilities are not understated and provisions are made for income and losses.
To be prudent is to be wise. This principle is simply telling accountants to be Wise and not overly wise when preparing FS.
Wrapping Up
I hope this piece has been insightful and that you’ve learned what accounting concepts and principles entail. Do ensure you use this when preparing financial statements. Until Next Time….
