The 13 principles of accounting provide a framework for preparing financial statements and ensuring consistency and comparability. While variations exist and some principles are more fundamental than others, a common list includes the following:
The 13 Generally Accepted Accounting Principles (GAAP)
Here's a breakdown of each principle:
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Accrual Principle: Revenue is recognized when earned, and expenses are recognized when incurred, regardless of when cash changes hands. This provides a more accurate picture of a company's financial performance over time. For example, if a company provides a service in December but doesn't receive payment until January, the revenue is recognized in December.
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Conservatism Principle: When uncertainty exists about a financial outcome, accountants should choose the option that is least likely to overstate assets or income and understate liabilities or expenses. This principle guides accountants to err on the side of caution. For example, if inventory value declines, the company writes down the inventory to its market value rather than its original cost.
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Consistency Principle: A business should consistently use the same accounting methods from period to period to allow for meaningful comparisons of financial statements over time. If a change is made, it must be disclosed and justified. For example, if a company uses FIFO (First-In, First-Out) for inventory valuation, it should continue to use FIFO unless there is a valid reason to switch.
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Cost Principle: Assets are recorded at their original cost, which is the historical cash-equivalent price paid to acquire them. This provides objective and verifiable information. While market values may change over time, the original cost remains on the books.
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Economic Entity Principle: The financial activities of a business should be kept separate and distinct from the personal financial activities of its owners and other businesses. This ensures that financial statements accurately reflect the performance of the specific business.
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Full Disclosure Principle: All information that could reasonably affect the decisions of investors and creditors should be disclosed in the financial statements or accompanying notes. This includes relevant information about a company's operations, risks, and uncertainties.
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Going Concern Principle: Assumes that a business will continue to operate in the foreseeable future. This justifies valuing assets based on their expected future use rather than their liquidation value. If there is substantial doubt about a company's ability to continue as a going concern, it must be disclosed.
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Matching Principle: Expenses should be recognized in the same period as the revenues they helped to generate. This ensures that financial statements accurately reflect the profitability of a business. For example, the cost of goods sold is recognized in the same period as the revenue from the sale of those goods.
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Materiality Principle: Only information that is significant enough to influence the decisions of users of financial statements needs to be disclosed. What is material depends on the size and nature of the item. For example, a small error may not be material for a large corporation but could be material for a small business.
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Monetary Unit Principle: Accounting information should be measured and reported in a stable monetary unit, such as the U.S. dollar. This simplifies accounting and allows for meaningful comparisons of financial information. While inflation can affect the value of money, the principle assumes a relatively stable monetary unit.
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Reliability Principle: Accounting information should be verifiable and objective. It should be based on evidence that can be supported by independent sources. This enhances the credibility of financial statements.
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Revenue Recognition Principle: Revenue should be recognized when it is earned and realized or realizable. This typically occurs when goods are delivered or services are rendered.
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Time Period Principle: The life of a business can be divided into artificial time periods (e.g., months, quarters, years) for reporting purposes. This allows for timely information to be provided to users of financial statements.
These principles, while sometimes overlapping, aim to create financial statements that are relevant, reliable, and comparable, leading to informed economic decision-making.
