Which accounting principle is followed when creating financial statements?

Accounting principles are the set guidelines and rules issued by accounting standards like GAAP and IFRS for the companies to follow while recording and presenting the financial information in the books of accounts. These principles help companies present a true and fair representation of financial statements.

As the name suggests, these principles are rules and guidelines maintaining which a company should report its financial data. Here is the list of the top 6 basic accounting principles –

Table of contents

Top 6 Basic Accounting Principles

Here is the list of basic accounting principles that the company often follows. Let’s have a look at them –

• Accrual Principles
• Consistency principleConsistency PrincipleAccording to the Consistency Principle, all accounting treatments should be followed consistently throughout the current and future periods unless compelled by law to change or the change provides a better accounting presentation. This concept prevents accounting fraud and ensures that financial statements are comparable across historical periods.read more
• Conservatism principle
• Going concern principle
• Matching principle
• Full disclosure principle

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Source: Accounting Principles (wallstreetmojo.com)

#1 – Accrual principle:

The company should record accounting transactionsAccounting TransactionsAccounting Transactions are business activities which have a direct monetary effect on the finances of a Company. For example, Apple representing nearly $200 billion in cash & cash equivalents in its balance sheet is an accounting transaction. read more in the same period it happens, not when the cash flow was earned. For example, let’s say that a company has sold products on credit. As per the accrual principle, the sales should be recorded during the period, not when the money would be collected.

#2 – Consistency principle:

If a company follows an accounting principle, it should keep following the same principle until a better one is found. If the consistency principle is not followed, the company will jump around here and there, and financial reportingFinancial ReportingFinancial reporting is a systematic process of recording and representing a company’s financial data. The reports reflect a firm’s financial health and performance in a given period. Management, investors, shareholders, financiers, government, and regulatory agencies rely on financial reports for decision-making.read more will be messy. As a result, it would be difficult for investors to see where the company has been going and how it is approaching its long-term financial growth.

#3 – Conservatism principle:

As per the conservatism principle, accounting faces two alternatives – one, report a more significant amount, or two, report a lesser amount. To understand this in detail, let’s take an example. Let’s say that Company A has reported that it has machinery worth $60,000 as its cost. Now, as the market changes, the selling value of this machinery comes down to $50,000. Now the accountant has to choose one from two choices – first, ignore the loss the company may incur on selling the machinery before it’s sold; second, report the loss on machinery immediately. As per the conservatism principle, the accountant should go with the former choice, i.e., to report the loss of machinery even before the loss would happen. Conservatism principleConservatism PrincipleThe conservatism principle of accounting guides the accounting, according to which there is any uncertainty. All the expenses and liabilities should be recognized. In contrast, all the revenues and gains should not be recorded, and such revenues and profits should be recognized only when there is reasonable certainty of its actual receipt.read more encourages the accountant to report more significant liability amount, lesser asset amount, and also a lower amount of net profits.

#4 – Going concern principle:

As per the going concern principle, a company would operate for as long as it can in the near or foreseeable future. Therefore, by following the going concernGoing ConcernAny analyst analyzing a company will be left to a basic assumption that the company does not go bankrupt or file a chapter 11 bankruptcy. This basic assumption allows the analyst to think that there is no immediate danger to the company. The company can operate until infinity is called the principle of going concern. principle, a company may defer its depreciation or similar expenses for the next period.

#5 – Matching principle:

The matching principle is the basis of the accrual principle we have seen before. As per the matching principle, it’s said that if a company recognizes and records revenue, it should also record all costs and expenses related to it. So, for example, if a company records its sales or revenues, it should also record the cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read more and also other operating expenses.

#6 – Full disclosure principle:

As per this principle, a company should disclose all financial informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc.read more to help the readers see the company transparently. Without the full disclosure principleFull Disclosure PrincipleFull Disclosure Principle is an accounting policy backed by GAAP and IFRS, asking the management of an organization to disclose every relevant and material financial information to creditors, investors and any other stakeholder who depend on the financial reports and decision-making process.read more, the investors may misread the financial statements because they may not have all the information available to make a sound judgment.

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