Top 10 Basic Accounting Principles Explained For 2024

A comprehensive overview of essential accounting guidelines.

What Are Accounting Principles? 

Accounting principles have existed for thousands of years, but following the Great Depression, standards were established to control reporting. 

These accounting principles evolved into the generally accepted accounting practice (GAAP) today, governed by the Financial Accounting Standards Board (FASB). 

Accountants in the United States primarily use GAAP, while International Financial Reporting Standards are used by accountants globally. 

GAAP and International Financial Reporting Standards ensure financial statements are uniform, making understanding a business's financials easier. 

Definition of Accounting Principles 

• Generally accepted accounting principles serve as the foundation for reporting financial information for publicly traded companies. 
• They guide the comprehensive suite of accounting standards used in financial reporting. 
• These generally accepted accounting principles allow you to examine financial data using standardized terms and methods. 

Importance of Accounting Principles 

• Consistent application of accounting principles is crucial for accurate financial reporting. 
• They provide consistency and transparency in your financial statements. 
• The principles allow investors and other parties to analyze and extract information accurately. 
• They ensure financial data is reported in consistent accounting terms over an accounting period. 

Purpose of Accounting Principles 

In 2001, the Enron scandal resulted in many people losing vast amounts of money, and one of the world's largest accounting firms folded. 

The Sarbanes-Oxley Act was introduced and placed harsh restrictions on accountants to ensure they behaved ethically in their consulting engagements. 

All these measures were implemented to make businesses follow basic accounting concepts and create accurate financial reports. 

Publicly traded companies must accurately represent their operations by adhering to governmental accounting standards and board dictates. 

They help facilitate decision-making by contributing to a clear understanding of the fair value of assets, liabilities, and equity. 

By following these basic accounting principles, financial statements help owners, investors, and banks identify and assess risks associated with a business. 

Generally Accepted Accounting Principles (GAAP) 

GAAP represents a set of official, common standards followed by accounting professionals in the USA and worldwide when compiling a set of accounts. 

The Financial Accounting Standards Board codified these basic accounting terms for accuracy and transparency, consisting of 10 key components. 

Key Components of GAAP 

1. Principle of regularity 
2. Principle of consistency 
3. Principle of sincerity 
4. Principle of permanence of methods 
5. Principle of non-compensation 
6. Principle of prudence 
7. Principle of continuity 
8. Principle of periodicity 
9. Principle of materiality or full disclosure 
10. Principle of good faith 

Top 10 Basic Accounting Principles Explained for 2024 

GAAP is aimed at public companies listed on the stock exchange, and many of its rules and regulations do not apply to small private businesses. 

For this reason, professional accountants will use their discretion when utilizing the guidelines within GAAP when producing financial statements for your business. 

These are our top ten basic accounting principles for small businesses: 

10. Accrual Principle 

The accrual principle refers to recording transactions when they occur and not only when they affect your cash flow. 

Accrual-based accounting relates to income and expenses and requires that you enter the transaction into your books on the date it occurs. 

If your customer purchases on the first day of the month, you must record that sale immediately, even if they only pay for it the following month. 

In the same way, if you order stock and receive it from your supplier on the 15th of the month, you must record it in your books on that date. 

You may only pay for your stock after 30 days, but the accrual principle ensures the value received is entered into the correct accounting period. 

This makes sense if you consider that you can make sales of that stock to your customers immediately, resulting in a gross profit on the item. 

If you didn't record the purchase and sale when transactions occurred, your sales profit would be overstated one month and understated the next. 

Businesses with annual turnover over $25 million must use the accrual method by the IRS, while smaller businesses can choose the cash basis. 

Using the cash basis can help a business experiencing a cash shortage and, in many cases, is a more straightforward system to implement. 

This principle is closely tied to the revenue recognition principle; such accounting practices ensure clients record business transactions correctly. 

9. Conservatism Principle 

The conservatism principle requires accountants to recognize all potential liabilities and expenses when confident they are applicable. 

When recording assets and revenues, the accountant must verify the amounts reflected to ensure they are definitely due. 

If there is doubt about the certainty of the asset or revenue, then it is treated accordingly, which may result in lower profits being reported. 

This principle is in place to ensure a company does not over-inflate its profits or appear to be in a better financial position than it actually is. 

When accounting for startups, the conservatism principle will ensure a fair and accurate picture of the company is reflected in the financial reports. 

8. Consistency Principle 

Using the same methods and principles for each reporting period is essential to get the most out of a set of financial statements. 

This principle requires a business to use the same methods, principles, and procedures to produce its financial statements yearly. 

Should something change in the current year that affects how values or figures are reported, then adjustments must be made to reveal its historical effect. 

Using the consistency principle helps analysts and business owners accurately gauge trends and compare the financial health of companies across various periods. 

When making changes that affect the consistency principle, your accountant will compile comprehensive notes in the financial statements to explain the differences. 

7. Cost Principle 

The cost principle requires accountants to record equity investments, assets, and liabilities based on their value at the time of the original transaction. 

Using the cost principle guarantees your balance sheet remains consistent across all periods, providing stability when presenting financial information. 

The historical cost principle facilitates meticulous accounting by requiring originating documents for every transaction, ensuring transparency and easy verification of asset values. 

The integrity of your financial records is maintained with no need for frequent adjustments, and costs remain static without the volatility of fair values. 

If the timing of the original transaction is in question, auditors and accountants rely on legal documents and delivery documents to establish accurate dates. 

This is one of the most basic accounting principles ensuring your annual financial statements are accurate and transparent. 

6. Economic Entity Principle 

It is essential to keep your business finances separate from stakeholders' finances by avoiding using business funds for personal expenses. 

Should you not follow the economic entity principle, your bookkeeping becomes much more complex and may result in legal problems or issues with the IRS. 

Personal expenses must be recorded separately whether you are a sole trader or in a general partnership, limited liability partnership, or corporation. 

This is one of the most important financial tips we can give you, as it avoids a lot of unpleasantness when taxes are due. 

Good governance and ethics dictate monies expended on behalf of an owner or shareholder must be reflected in a loan account or as salaries. 

This principle ensures the company's financial position is accurate and helps avoid potential problems when declaring your income to the IRS. 

5. Full Disclosure Principle 

The full disclosure principle requires that your financial statements include all the information necessary to promote transparency and accountability. 

By divulging all pertinent information, stakeholders can make well-informed decisions based on a comprehensive understanding of the company's financial position. 

Applying this principle to the preparation of financial statements relies heavily on an accountant's judgment, as the volume of information is vast. 

It is incumbent on the management team to exercise their discretion when presenting data that may have a material effect on the financial statements. 

The company's financial position and performance may be affected by unresolved legal proceedings or ongoing disputes requiring disclosure in the financial statements. 

Full disclosure necessitates reporting existing accounting policies and any changes made to these policies, such as alterations in asset valuation methods. 

Disclosing information may be accomplished by including it within line items in the income statement, balance sheet, or the accompanying footnotes. 

4. Going Concern Principle 

The going concern principle is predicated on the assumption that a business can and will continue to operate for the foreseeable future. 

The assumption is, therefore, that the business is in good financial condition and will remain in operation as it has done in the past. 

This principle allows companies to defer recognition of expenses that may fall due in future accounting periods and aren't recorded in the current period. 

An example of a non-cash flow expense is depreciation, which can be allocated to several future periods in recognition of reduced asset values. 

One of the accounting tips that can reduce your tax liability is to claim the full amount of your depreciation deduction each year. 

Accountants and auditors may reach different conclusions from owners and managers regarding the company's ability to repay loans or meet other obligations. 

In this case, the company may need to consider restructuring or restating the liquidation value of assets on the balance sheet. 

3. Matching Principle 

The matching principle refers to recording expenses and related revenue on the income statement in the relevant periods. 

This principle goes hand-in-hand with the accrual principle, so when a customer purchases a product or service, associated costs are recorded, too. 

If a product is being manufactured, an accurate bill of materials must reflect input costs and adjustments to stock values. 

To accurately reflect the cost of goods sold (COGS), stocktakes must be scheduled at the end of specific reporting periods to facilitate required adjustments. 

In the case of a public company, your accountant or auditor needs to verify the stock take, ensuring an appropriate valuation method is employed. 

If a stock item cannot be identified (in the case of identical inputs), then the last-in-first-out (LIFO) valuation method may be used. 

Stock valuation methods are noted in the financial statements, and a note is made if the valuation method differs from previous periods. 

2. Monetary Unit Principle 

The monetary unit principle is one of the most fundamental accounting principles, stipulating that all financial transactions must be recorded in a common monetary unit. 

This is typically the currency of the country where the business operates, and there are various rules to follow when converting from other currencies. 

This principle assumes the currency's stability over time and disregards any changes in the purchasing power of money. 

It provides a uniform and consistent measure for recording and reporting all business transactions, allowing for easier comparison and analysis. 

Using a single monetary unit simplifies accounting processes, providing an objective basis for recording transactions, as monetary units are tangible and easily quantifiable. 

The primary deficiency in using this principle is that it does not account for changes in the value of money due to inflation or deflation. 

Over time, the purchasing power of money may fluctuate, and non-monetary items, such as employee skill levels or intellectual property, are not accounted for. 

This can impact the accuracy of financial statements, and crucial aspects of a business's value may be missing, leading to potential misinterpretation by users. 

While the monetary unit principle provides a foundational framework, it has limitations, and supplementary information and adjustments may be required when analyzing financial statements. 

1. Reliability Principle 

The reliability principle underlies the importance of presenting accurate and relevant information, ensuring financial statements reflect an entity's financial position. 

It requires that only transactions supported by solid evidence should be recorded, with items such as supplier invoices serving as concrete proof of incurred expenses. 

This requirement is particularly crucial for auditors, who rely on tangible evidence, such as invoices, to validate the authenticity of recorded transactions. 

Auditors play a pivotal role in upholding the reliability principle by systematically seeking evidence that substantiates the existence of a selection of transactions. 

This focus on proof enhances the reliability and trustworthiness of financial reporting with invoices, purchase receipts, bank statements, and canceled checks to support transactions. 

The reliability principle increases the credibility of financial statements by relying on tangible evidence, instilling confidence in stakeholders. 

Summary 

Now that you have a fundamental understanding of basic accounting standards for small businesses, it's time to implement them. 

These foundational guidelines will form the backbone of your financial reporting and assist you in better understanding your business and its financial position. 

They can serve as your compass for consistent, transparent, and accurate financial statements to supply your business with reliable and comprehensive financial information.