Introduction:
Accounting principles are some set of rules which every business should follow to have a smooth run of their business.
This principle makes things easier for the business to maintain financial statements.
Financial statements are the most significant aspects of the business because it gives them an idea of the functioning.
A financial statement is a complete record of the transactions and events in the business in the last year.
Accounting Principles are Generally Accepted rules which a business follows as they give them a complete framework of how to make things happen.
Business Entity Principle:
The business entity principle states that business and businessman should be treated as two different entities.
Transactions recorded in financial statements are prepared with the view of the business and not the owner.
A business owner is treated as a liability because he charges interest on capital on the capital invested in the business other than his share of profit which makes him the internal ability for the business.
On the other hand, if the businessman draws some money from the business, he should pay interest on drawings.
For example, Mr. A needs some money urgently, so he decides to withdraw it from the business, which makes him liable to pay the principal amount interest to the business.
Money Measurement Principle:
As the name suggests, the Money Measurement principle states that any transaction which holds a value in terms of money makes it to the books of accounts.
Transactions that are not cash or can not be expressed in the money value are not recorded.
The downside to this principle as other quality aspects like efficient human resources cannot be recorded in the books of accounts.
For example: A business should record purchases and sales that happened in the organization, if any dispute between the employees occurs, it is not possible to measure it in money form hence cannot be recorded in the books of accounts.
Accounting Period Principle:
The accounting period principle states that the business should follow a set period with intervals for the inspection of profits and losses and the expenses incurred in the organization in that particular period.
It helps the business to analyze and compare the two periods, which helps them to create strategies for the next term. Generally, April to March is considered an accounting period in most countries.
For example: If a business owner prepares books of accounts for his business from the last few years, he can analyze the profits and losses as many as expenses over the years to look at what should be treated.
Full Disclosure Principle:
The full disclosure principle states that a business needs to disclose the relevant information to their stakeholders, but by no means does it states that a business should disclose their business secrets.
The relevant information is different for different people. For a creditor, relevant information could be the ability to repay the debt of the business.
For example: A company should publish their detailed balance sheet For the present shareholder as well as for the public willing to invest in your company.
P.S: Contingent liabilities are shown as the footnote in the balance sheet.
Contingent liabilities:
Contingent liability is a liability that may or may not occur. Mostly it depends upon the future results.
Example- winning a court case.
Materiality Principle:
The materiality principle states that it is crucial to disclose the relevant information, but it doesn’t mean to disclose the relevant information also.
As per this principle, the company needs to disclose the information that holds some material value to them. Material value could be different for different people.
For example: 1 unit of mobile may not have a great significance for the mobile manufacturing company but the retailer selling that mobile has.
If anything happens with the mobile like damage, manufacturing companies need not show that in accounts, but the retailer should create the entry in his books of accounts.
Principle Of Conservatism:
The principle of conservatism states that a business should be ready for anticipated losses and create an entry in the books of accounts.
On the contrary, the future profits incurred will make it to the books of accounts. This principle helps the company to prepare itself for future uncertainties.
The principle of conservatism emphasizes repairing books of account with utmost care.
For example: A business invests a hefty amount and anticipates gains in the future. They can’t show this profit in the books of accounts until there incurred this gain.
Cost Principle:
The cost principle is also known as the historical cost principle states that an asset should be recorded on the cost it is acquired.
Acquired cost means the original cost of the Asset Plus any modification or installation made to the original asset. Further calculations will be subject to the price recorded in the books of account.
A change in the value of the asset will not have any impact.
This asset will lose its value over the years as depreciation will be applied.
For example: a company purchases machinery for $5000 and pays $200 in installation.
The cost of machinery will be $5200, and depreciation is applicable on this amount.
Dual Aspect Principle:
The dual aspect principle states that accounting is based on double-entry bookkeeping.
There will be two entries for a transaction, Debit, and Credit. of an equal amount.
For Example: Depreciation on an asset will firstly have a debit impact on Profit and loss and will be credited from the asset as the 2nd effect.
