Monique H. answered • 03/21/19
Enrolled Agent and Accountant with concise lectures
Accounting principles serve the purpose of creating uniformity across financial reports created by multiple reporting entities (businesses), in varying business sectors. This allows the user of financial reports the ability to compare apples to apples. One way financial analysts evaluate business performance is by calculating ratios, thus, a high level of financial reporting uniformity is necessary for coming to the best conclusions.
Accounting principles together with accounting conventions form the general framework to guide accountants with preparing financial reports. Here are the four (4) main accounting principles:
1) Historical Cost
2) Revenue Recognition
3) Matching of Expenses
4) Full Disclosure
1) Historical Cost. Applying this principle ascertains that balance sheet assets are carried at purchase price. These balances are based on “hard evidence,” the amount derived from an actual purchase transaction, as opposed to their present value.
2) Revenue Recognition. Applying this principle reflects revenue when earned as opposed to when the cash payment is received. By doing such, the business is evaluated on its true sales/service performance for the period. The cash payments from clients (account receivable) is outside of the control of the business conducting the service. The business conducting the service increases revenue and gives credit to its client client by billing them for future payment.
3) Matching of Expenses. This principle provides consistency in reporting across financial periods by reporting expenses when they are incurred as opposed to when paid. Furthermore, the expense is said to be incurred with regards to a) contractual obligations, and b) matching those expenses to the period when generating revenue was intended, not actually earned. Again, when this principle is applied to financial reporting the performance of the reporting entity can be better assessed.
4) Full Disclosure. This is a catch-all principle for the event that a business contingency exists but no hard-trail has been initiated. The most common example for adisclosure is one for the event of a law-suit that might end up as a loss for the business.
