top of page

Understanding the Basic Principles of Accounting

Writer's picture: TrentTrent
a monthly expense guideline document with pencil

Accounting is governed by a set of fundamental assumptions and principles commonly referred to as generally accepted accounting principles. A basic level of understanding of these principles can provide context and help to make accounting practices more easily comprehended. As a small business owner understanding these principles will allow a greater understanding of how your financial reports are produced. The following is a brief overview of some of the key accounting principles that impact financial reporting.


The revenue principle states that revenue is earned when a sale is made or when goods or services are provided. According to the revenue principle, when it comes to the sale of goods, revenue is earned when legal ownership of the goods passes from the seller to the buyer. The expense principle states that an expense occurs when a business uses goods or receives services. Regardless of when the bill is received, the expense principle states that the expense is incurred when goods or services are received. The matching principle is related to both the revenue and the expense principles and states that expenses should be matched with their corresponding revenue. For example, according to the matching principle, if you sell goods, you should record the expense of your goods at the time that you sell the goods. The expense should not be recorded when the goods are purchased, but rather when the goods are sold. The accrual method of accounting is the result of applying the revenue, expense and matching principles.


The cost principle states that assets should be recorded at cost, or the price that was paid to acquire them. Even if assets appreciate overtime, they are not to be revalued or adjusted for financial reporting purposes.


The objectivity principle states that accounting reports should be objective, factual, verifiable and consistent. Accounting reports should avoid subjectivity and should use the same accounting methods each accounting period so meaningful comparisons between different accounting periods can be made.


The continuity or going concern assumption assumes that a business will continue to operate indefinitely. As a result of this assumption, assets are presumed to have resale value and do not have to be sold at fire-sale values and debt does not need to be paid off before maturity.


The monetary unit/ unit of measure assumption requires a business’s financial reports to include only quantifiable transactions. Economic events that cannot be easily quantified in monetary units (such as hiring a new CEO) are therefore not included in financial reports.

This assumption also requires that accounting reports must be recorded using a stable currency like the U.S. dollar.


The separate or economic entity assumption requires that business’s accounting records be kept separate and distinct from their owners. It requires financial records to be separately maintained for each economic entity and to not include the personal assets or liabilities of their owners.


While these principles may seem technical in many ways you probably already utilize them in your day-to-day life. You pick up lunch for your office by paying for the food when you receive it. You then submit the receipt to your employer for reimbursement. This simple task utilizes most of these accounting principles. The restaurant that provides you the food, records a sale when you pay and records an expense for the cost of the food sold to you. You submit an expense claim to your company who mark the item to be paid to you, which creates an expense for the company. You assume your employer will still be in business next week to reimburse you. All these transactions occur in a measured and quantifiable way. For example, you can measure the mileage that you incur to drive to the restaurant and may submit that for reimbursement as well, however you may not be able to measure the lost time you could have utilized for networking or working within the office during that time. You also expect your employer to reimburse you in a form of business petty cash, or a check from the company. You do not expect your direct report to write you a personal check from his joint checking account.


In conclusion, understanding how your accountant thinks through these various principles may assist in your reporting and record collection. In many ways accounting is done every day in our lives without our realization of the ebb and flow of these transactions. Gaining greater insight to these core principles only allows for greater business insights as you grow your company.

6 views0 comments

Comments


Distressed-line-down.png
  • alt.text.label.Instagram
  • Facebook

©2023 by Third Mesa. All rights reserved.

®Intuit and QuickBooks are registered trademarks and/or registered service marks of Intuit Inc., used with permission.

bottom of page