Accounting Principles Explained: How
They Work, GAAP, IFRS
What Are Accounting Principles?
Accounting principles are the rules and guidelines that companies and
other bodies must follow when reporting financial data. These rules make it
easier to examine financial data by standardizing the terms and methods
that accountants must use.
The International Financial Reporting Standards (IFRS) is the most widely
used set of accounting principles, with adoption in 167 jurisdictions. The
United States uses a separate set of accounting principles, known
as generally accepted accounting principles (GAAP).1
KEY TAKEAWAYS
Accounting standards are implemented to improve the quality of
financial information reported by companies.
In the United States, the Financial Accounting Standards Board
(FASB) issues generally accepted accounting principles (GAAP).
GAAP is required for all publicly traded companies in the U.S.; it is
also routinely implemented by non-publicly traded companies as
well.
Internationally, the International Accounting Standards Board (IASB)
issues International Financial Reporting Standards (IFRS).
The FASB and the IASB sometimes work together to issue joint
standards on hot-topic issues, but there is no intention for the U.S. to
switch to IFRS in the foreseeable future.
What Are the Basic Accounting Principles?
Some of the most fundamental accounting principles include the following:
Accrual principle
Conservatism principle
Consistency principle
Cost principle
Economic entity principle
Full disclosure principle
Going concern principle
Matching principle
Materiality principle
Monetary unit principle
Reliability principle
Revenue recognition principle
, Time period principle
Generally Accepted Accounting Principles (GAAP)
Generally accepted accounting principles (GAAP) are uniform accounting
principles for private companies and nonprofits in the U.S. These
principles are largely set by the Financial Accounting Standards Board
(FASB), an independent nonprofit organization whose members are
chosen by the Financial Accounting Foundation.2
International Financial Reporting Standards (IFRS)
The International Accounting Standards Board (IASB) issues International
Financial Reporting Standards (IFRS). These standards are used in more
than 120 countries, including those in the European Union (EU).6
The Securities and Exchange Commission (SEC) , the U.S. government
agency responsible for protecting investors and maintaining order in
the securities markets, has expressed interest in transitioning to IFRS.
However, because of the differences between the two standards, the U.S.
is unlikely to switch in the foreseeable future.5
Consistency principle. This is the concept that, once you adopt an
accounting principle or method, you should continue to use it until a
demonstrably better principle or method comes along. Not following
the consistency principle means that a business could continually
jump between different accounting treatments of its transactions that
makes its long-term financial results extremely difficult to discern.
Cost principle. This is the concept that a business should only record
its assets, liabilities, and equity investments at their original
purchase costs. This principle is becoming less valid, as a host of
accounting standards are heading in the direction of adjusting assets
and liabilities to their fair values.
Economic entity principle. This is the concept that the transactions of
a business should be kept separate from those of its owners and
other businesses. This prevents intermingling of assets and liabilities
among multiple entities, which can cause considerable difficulties
when the financial statements of a fledgling business are first
audited.
Full disclosure principle. This is the concept that you should include
in or alongside the financial statements of a business all of the
, information that may impact a reader's understanding of those
statements. The accounting standards have greatly amplified upon
this concept in specifying an enormous number of informational
disclosures.
Going concern principle. This is the concept that a business will
remain in operation for the foreseeable future. This means that you
would be justified in deferring the recognition of some expenses,
such as depreciation, until later periods. Otherwise, you would have
to recognize all expenses at once and not defer any of them.
Matching principle. This is the concept that, when you record
revenue, you should record all related expenses at the same time.
Thus, you charge inventory to the cost of goods sold at the same
time that you record revenue from the sale of those inventory items.
This is a cornerstone of the accrual basis of accounting. The cash
basis of accounting does not use the matching the principle.
Materiality principle. This is the concept that you should record a
transaction in the accounting records if not doing so might have
altered the decision making process of someone reading the
company's financial statements. This is quite a vague concept that is
difficult to quantify, which has led some of the more picayune
controllers to record even the smallest transactions.
Monetary unit principle. This is the concept that a business should
only record transactions that can be stated in terms of a unit of
currency. Thus, it is easy enough to record the purchase of a fixed
asset, since it was bought for a specific price, whereas the value of
the quality control system of a business is not recorded. This
concept keeps a business from engaging in an excessive level of
estimation in deriving the value of its assets and liabilities.
Reliability principle. This is the concept that only those transactions
that can be proven should be recorded. For example, a supplier
invoice is solid evidence that an expense has been recorded. This
concept is of prime interest to auditors, who are constantly in search
of the evidence supporting transactions.
, Revenue recognition principle. This is the concept that you should
only recognize revenue when the business has substantially
completed the earnings process. So many people have skirted
around the fringes of this concept to commit reporting fraud that a
variety of standard-setting bodies have developed a massive amount
of information about what constitutes proper revenue recognition.
Time period principle. This is the concept that a business should
report the results of its operations over a standard period of time.
This may qualify as the most glaringly obvious of all accounting
principles, but is intended to create a standard set of comparable
periods, which is useful for trend analysis.
TYPES OF WORKERS:
Hired Worker: These are workers who are employed by others
(employers) and receive a salary/wage as compensation for work.
Hired workers may again be of two types:
Casual Worker: These are workers who are engaged by employers on
a temporary basis for some specific work. They are not permanent and
do not receive any social security or other work benefits. Example:
Construction workers are contracted only for specific projects and not
hired permanently. Seasonal workers such as those engaged on the
farm only during the harvest season are also classified as casual
workers.
Regular Salaried Worker: These are workers hired by employers on a
permanent basis and are paid regular salaries/wages for their work.
Example: Chartered accountants, teachers, sports trainers at a sports
club.
Self-Employed: The other set of workers are those who are not
employed by some employer but who own and work for their own
enterprise. Example: Proprietors, business persons.
ORGANISED SECTOR:
The sector, which is registered with the government is called an
organised sector. In this sector, people get assured work, and
the employment terms are fixed and regular.
The sector is regulated and taxed by the government.
There are some benefits provided to the employees working
They Work, GAAP, IFRS
What Are Accounting Principles?
Accounting principles are the rules and guidelines that companies and
other bodies must follow when reporting financial data. These rules make it
easier to examine financial data by standardizing the terms and methods
that accountants must use.
The International Financial Reporting Standards (IFRS) is the most widely
used set of accounting principles, with adoption in 167 jurisdictions. The
United States uses a separate set of accounting principles, known
as generally accepted accounting principles (GAAP).1
KEY TAKEAWAYS
Accounting standards are implemented to improve the quality of
financial information reported by companies.
In the United States, the Financial Accounting Standards Board
(FASB) issues generally accepted accounting principles (GAAP).
GAAP is required for all publicly traded companies in the U.S.; it is
also routinely implemented by non-publicly traded companies as
well.
Internationally, the International Accounting Standards Board (IASB)
issues International Financial Reporting Standards (IFRS).
The FASB and the IASB sometimes work together to issue joint
standards on hot-topic issues, but there is no intention for the U.S. to
switch to IFRS in the foreseeable future.
What Are the Basic Accounting Principles?
Some of the most fundamental accounting principles include the following:
Accrual principle
Conservatism principle
Consistency principle
Cost principle
Economic entity principle
Full disclosure principle
Going concern principle
Matching principle
Materiality principle
Monetary unit principle
Reliability principle
Revenue recognition principle
, Time period principle
Generally Accepted Accounting Principles (GAAP)
Generally accepted accounting principles (GAAP) are uniform accounting
principles for private companies and nonprofits in the U.S. These
principles are largely set by the Financial Accounting Standards Board
(FASB), an independent nonprofit organization whose members are
chosen by the Financial Accounting Foundation.2
International Financial Reporting Standards (IFRS)
The International Accounting Standards Board (IASB) issues International
Financial Reporting Standards (IFRS). These standards are used in more
than 120 countries, including those in the European Union (EU).6
The Securities and Exchange Commission (SEC) , the U.S. government
agency responsible for protecting investors and maintaining order in
the securities markets, has expressed interest in transitioning to IFRS.
However, because of the differences between the two standards, the U.S.
is unlikely to switch in the foreseeable future.5
Consistency principle. This is the concept that, once you adopt an
accounting principle or method, you should continue to use it until a
demonstrably better principle or method comes along. Not following
the consistency principle means that a business could continually
jump between different accounting treatments of its transactions that
makes its long-term financial results extremely difficult to discern.
Cost principle. This is the concept that a business should only record
its assets, liabilities, and equity investments at their original
purchase costs. This principle is becoming less valid, as a host of
accounting standards are heading in the direction of adjusting assets
and liabilities to their fair values.
Economic entity principle. This is the concept that the transactions of
a business should be kept separate from those of its owners and
other businesses. This prevents intermingling of assets and liabilities
among multiple entities, which can cause considerable difficulties
when the financial statements of a fledgling business are first
audited.
Full disclosure principle. This is the concept that you should include
in or alongside the financial statements of a business all of the
, information that may impact a reader's understanding of those
statements. The accounting standards have greatly amplified upon
this concept in specifying an enormous number of informational
disclosures.
Going concern principle. This is the concept that a business will
remain in operation for the foreseeable future. This means that you
would be justified in deferring the recognition of some expenses,
such as depreciation, until later periods. Otherwise, you would have
to recognize all expenses at once and not defer any of them.
Matching principle. This is the concept that, when you record
revenue, you should record all related expenses at the same time.
Thus, you charge inventory to the cost of goods sold at the same
time that you record revenue from the sale of those inventory items.
This is a cornerstone of the accrual basis of accounting. The cash
basis of accounting does not use the matching the principle.
Materiality principle. This is the concept that you should record a
transaction in the accounting records if not doing so might have
altered the decision making process of someone reading the
company's financial statements. This is quite a vague concept that is
difficult to quantify, which has led some of the more picayune
controllers to record even the smallest transactions.
Monetary unit principle. This is the concept that a business should
only record transactions that can be stated in terms of a unit of
currency. Thus, it is easy enough to record the purchase of a fixed
asset, since it was bought for a specific price, whereas the value of
the quality control system of a business is not recorded. This
concept keeps a business from engaging in an excessive level of
estimation in deriving the value of its assets and liabilities.
Reliability principle. This is the concept that only those transactions
that can be proven should be recorded. For example, a supplier
invoice is solid evidence that an expense has been recorded. This
concept is of prime interest to auditors, who are constantly in search
of the evidence supporting transactions.
, Revenue recognition principle. This is the concept that you should
only recognize revenue when the business has substantially
completed the earnings process. So many people have skirted
around the fringes of this concept to commit reporting fraud that a
variety of standard-setting bodies have developed a massive amount
of information about what constitutes proper revenue recognition.
Time period principle. This is the concept that a business should
report the results of its operations over a standard period of time.
This may qualify as the most glaringly obvious of all accounting
principles, but is intended to create a standard set of comparable
periods, which is useful for trend analysis.
TYPES OF WORKERS:
Hired Worker: These are workers who are employed by others
(employers) and receive a salary/wage as compensation for work.
Hired workers may again be of two types:
Casual Worker: These are workers who are engaged by employers on
a temporary basis for some specific work. They are not permanent and
do not receive any social security or other work benefits. Example:
Construction workers are contracted only for specific projects and not
hired permanently. Seasonal workers such as those engaged on the
farm only during the harvest season are also classified as casual
workers.
Regular Salaried Worker: These are workers hired by employers on a
permanent basis and are paid regular salaries/wages for their work.
Example: Chartered accountants, teachers, sports trainers at a sports
club.
Self-Employed: The other set of workers are those who are not
employed by some employer but who own and work for their own
enterprise. Example: Proprietors, business persons.
ORGANISED SECTOR:
The sector, which is registered with the government is called an
organised sector. In this sector, people get assured work, and
the employment terms are fixed and regular.
The sector is regulated and taxed by the government.
There are some benefits provided to the employees working
