How to Apply Accounting Principles and Concepts

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All accountants in the United States are required to follow Generally Accepted Accounting Principles. These principles, regulated by the Financial Accounting Standards Board, apply to the financial statements of all business entities. The principles set forth by GAAP are divided into three categories: Assumptions are reasonable determinations an accountant can make in a given situation; principles are regulations that accountants must follow; considerations are potential deviations that an accountant must contemplate in compiling his data. These principles should be known, understood and followed in the practice of accounting.

Assumptions

Separate all business transactions from personal transactions, even if the business is a sole proprietorship. Keep them segregated for accounting. This is known as the “economic entity principle.”

Assume that the business will remain in operation. This principle, known as “going concern,” is only inapplicable when liquidation is a certainty.

State the time period clearly in financial statement headings. The figures for a quarterly income statement will be different from year-end numbers. GAAP requires you to make the distinction up-front. This principle is known as the “periodicity principle.”

Prepare statements using a single currency, unadjusted for inflation. For example, if you use U.S. dollars, make no distinction between the value from 1990 and the value from 2010. This principle is known as the “monetary unit principle.”

Principles

Present all information in a clear, understandable manner. Clarity will leave less room for interpretation. This principle is known as “full disclosure.”

Match all revenues with expenses within the appropriate time frame. Recognize expenses only when they produce revenue as a result. For example, report expenses to create products in the fourth quarter of 2010 to generate revenue in the first quarter of 2011 in 2011. This is known as the “matching principle.”

Account for all assets at the original cost. Do not account for inflation or markup. This principle is known as the “historical cost principle.”

Record revenue when it is realized. If you perform work at the end of 2011 and send out a bill that is not paid until 2012, the revenue is incurred in 2011. Record the income for 2011. This principle is known as the “revenue recognition principle.”

Considerations

Provide backup evidence for all entries on financial statements. The concept of providing hard evidence to support information is known as the “objectivity principle.”

Consider the relevance of the items on the statement. Each item should be considered material. This is known as the “materiality principle.”

Favor conservative numbers over going out on a limb. GAAP states that companies should take a conservative approach to accounting. This is known as the “conservatism principle.”

Maintain the same accounting methods and principles each year. This principle is known as the “consistency principle.”

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