AuthorConner Schryver is the founder and CEO of Bookkeep & Prosper Archives
August 2023
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Accounting principles are the rules and benchmarks in the accounting field that a company should follow while reporting the financial statements. In the USA the Financial Standards Accounting Board (FASB) and the Securities Exchange Commission (SEC) have endorsed the U.S. Generally Accepted Accounting Principles (GAAP). Compliance with the Generally Accepted Accounting Principles requires that accountants and bookkeepers follow the Basic Principles of Accounting. It may feel as if your accounting procedures are functioning for you. However, when the moment arrives where you need accurate reporting, not standardizing your financial statements will cost you time and money. So, why are the Basic Principles of Accounting important? Following these principles standardizes accounting procedures and ensures that a company’s financial statements are complete, consistent, and comparable. This impacts business owners the most when applying for business loans, selling their company, or buying another business. Most financial institutions require GAAP compliant financial statements as part of their debt covenants and investors are wary of investing in non-GAAP compliant companies as revenue numbers can be misleading. It may feel as if your accounting procedures are functioning for you. However, when the moment arrives where you need accurate reporting, not standardizing your financial statements will cost you time and money. Basic Accounting Principles (Rulebook governed by Financial Accounting Standards Board and controlled by the Generally Accepted Accounting Principles)1. Economic Entity AssumptionThe Economic Entity Assumption outlines the requirement that all business and personal transactions must be separated. This may be confusing if you are a sole proprietor and you are thinking about filing your business and personal taxes as one entity. However, for accounting purposes, the business and all business transactions need to be separate from your personal transactions. If you don’t have a business checking account you will need to open one to keep your transactions separate. 2. Monetary Unit AssumptionThe Monetary Unit Assumption states that all transactions in your books must be in the same currency. If you headquarter in the United States then your transactions should be recorded in U.S. dollars. So, if you operate or have expenses overseas, those transactions must be recorded in U.S. dollars. The same goes for investments in cryptocurrency, etc. 3. Time Period AssumptionThe Time Period Assumption states that financial reports must show results for a specific period of time and that the period of time is clearly shown on all reports. The time shown for the three main financial statements does differ. For example, the Income Statement and Statement of Cash Flow report financial data over a period of time i.e. week(s), month(s), year(s) while the Balance Sheet is a cumulative report and shows data as of a specific date. 4. Cost PrincipleThe cost principle requires that financial transactions are recorded, forever, as the original and historical cost. What this means is that we do not adjust for inflation or appreciation. So, you might wonder how you ever record the increase or decrease in value of an asset, say an office building. First, you record it at the original purchase price. Then, when the asset is sold, and if there is appreciation on the property, it can be recorded as a gain on sale of assets on the Income Statement. 5. Full Disclosure PrincipleThe Full Disclosure Principle states that business owners, accountants, bookkeepers, etc. must include all pertinent information as related to the function of a business’ financial statements must be included with the reports. 6. Going Concern PrincipleThe Going Concern Principle requires that the business being reported on be considered to continue to exist and function into the foreseeable future. This essentially allows the accrual method of accounting be used. If the assessment is that the business will not be able to carry on then the reports must disclose that information. 7. Matching PrincipleThe Matching Principle requires that businesses utilize the accrual method of accounting. This means that expenses are recorded at the time the corresponding revenue is earned. So, if you have supplies that were used to create the product you sell, you would not record the expense of those supplies until the product was sold and delivered. 8. Revenue Recognition PrincipleThe Revenue Recognition Principle states that revenue must be reported when it is earned, i.e. when the service is performed or the good is delivered. This means that if you receive cash in advance of for a good or service it should be recorded as unearned revenue, a liability on your balance sheet. 9. Materiality PrincipleThe Materiality Principle allows an accountant to use their professional judgment to determine if errors found in the books are insignificant or not. If they find them to be insignificant then they choose to disregard the error. For example, if there was a $1.00 sale that wasn’t recorded per the Revenue Recognition Principle the accountant could disregard it. 10. Conservatism PrincipleThe Conservatism Principle requires that when a transaction can be recorded in more than one way choose the method that shows a decrease in net income and/or a decrease in assets/equity and/or an increase in liabilities. Essentially, when faced with a choice in how to represent the business choose the way that shows more expense or liability than the way that shows greater profits or more assets. Bookkeep & ProsperHere at Bookkeep & Prosper we specialize in remote digital bookkeeping with services customized to serve your business. Response time is guaranteed within 36 hours or the next month of service is free. We take cyber security seriously using military grade systems for anti-virus, data encryption, and password management. Each month after closing out your books we will review with you the financial statements including the Income Statement, Balance Sheet, and Statement of Cash Flows so that you have a clear view of how your business is performing. If you do not yet have budget and budget review as a standard part of your business then we will work to create a budget over the course of the first year of service. If you are reading this article then you want to get serious about your books. Why not start today by scheduling an introductory phone call with me, Conner Schryver, and see if Bookkeep & Prosper is a good fit for your company.
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