Accounting Principles

Several basic accounting principles have been developed that are the basic building blocks that form the basis for modern accounting or today what we know of as “Generally Accepted Accounting Principles” or GAAP.

Without these core principles and common practices, the reporting of accounting would be inconsistent and unreliable. Additionally, these core principles provide a standardized way to compare financial reports between companies.

Below are some of the core accounting principles

Accounting Period Principle – A business should report the results of its operations over a standard period of time, typically monthly, quarterly, or annually to make useful comparisons.

Accrual Principle – Under the accrual accounting method, all accounting transactions are recorded in the period when it is earned, rather than when cash was received from the customer. This also holds for expenses as they are recorded when they were incurred, rather than when they were paid.

Consistency Principle – Once a business adopts an accounting method or policy, that method or policy should continue to be used in similar situations, unless there are reasonable reasons. Not following this principle means useful comparisons of financial statements over multiple accounting periods cannot be made due to inconsistent data being used

Cost Principle – A business should record its fixed short and long-term assets at the original cost and not fair value at the time of acquisition minus accumulated depreciation.

Economic Entity Principle – A business is considered a separate entity from its owners and should be kept separate from the business.

Full Disclosure Principle – All non-standard financial information or notes are disclosed in the financial statements to allow a reference point.

Going Concern Principle – Stipulates that a business is expected to continue indefinitely and assets are not intended to be sold immediately or liquidated.

Matching Principle – When revenue is recorded all related expenses are recorded in the same period to provide an accurate picture of the profitability of the business. 

Materiality Principle – Errors or omissions of financial accounting procedures that involve immaterial or small amounts may not need attention or correction as they would not alter business decisions.

Monetary Unit Principle – Business transactions that are recognized as monetary currency are only recorded in a business’s accounting records.

Reliability Principle – Only those transactions that have supporting documentation like a receipt and are accurate and unbiased should be recorded.

Revenue Recognition Principle – Revenue is only recognized only when it is earned.

Important Definitions

Some common basic accounting terms that you will likely come across when learning accounting concepts include:

Accounting Cycle – The accounting cycle refers to the process steps that are taken to close the books and generate financial statements.

Accounts Payable – Also referred to as A/P, accounts payable is a record of bills that have been entered into a ledger or accounting software, but have not yet been paid. 

Accounts Receivable – Also referred to as A/R, accounts receivable are the revenue a company has made to customers but has not yet collected payment on.

Accrual Method – The accrual method of accounting recognizes revenue and expenses on the day the transaction takes place, not when payment is received as in the cash method. 

Book Value – Book value refers to the value or net worth of a company if it liquidated all of its assets and paid back all liabilities.

Burn rate – The burn rate is a measure of how quickly a business is spending its cash reserves. 

Cash Method of Accounting –  Cash basis accounting or sometimes called cash accounting refers to income being recorded when customers pay (and not as sales are made as in accrual accounting) and expenses being recorded in the period in which they are actually paid. Learn more about the difference between cash accounting and accrual accounting.

Chart of accounts – The chart of accounts lists all of the accounts found in the general ledger, which is where all of your accounting entries reside.

Cost of Goods – Cost of Goods Sold (or COGS) are the expenses that directly relate to the cost of producing a product or delivering a service.

Current Assets – Current assets are assets that will be converted to cash within one year.

General Ledger – The general ledger is the record-keeping system for a company’s financial data.

Fixed Cost – A fixed cost is a cost that does not change regardless of how many sales are made, Common examples are things like labor or rent.

Gross Margin – Gross margin, better known as profit, is sales minus any costs associated with creating the product or service, divided by revenue.

Gross Income – Gross income, also known as gross profit is calculated by taking total revenue and subtracting the cost of creating the product. 

Journal Entry – Journal entries are a summary of a transaction and are how updates and changes are made to a company’s books.

Net Income – Net income, or net profit, is the revenue earned in a specific time period. Net income is calculated by taking revenue and subtracting all expenses such as COGS, operating expenses, depreciation, and taxes.

Present Value – Present value is the current value of a future sum of money based on a specific rate of return.

Stockholders’ Equity – Stockholder’s equity, sometimes referred to as owner’s equity is the money invested by the owners into the company. 

Trial Balance – The trial balance is recorded at the end of an accounting period in the general ledger. 

Variable Expense – A variable expense is one where the amount changes (or varies) in proportion to the change in volume. Common examples include labor, commissions, or raw materials. 

Working capital – Working capital is calculating current assets and subtracting current liabilities.

Next Section: Lesson 2 – Double Entry Bookkeeping