We are currently living in a business atmosphere in which the competition among firms is very high. Adopting every possible method to improve the firm’s productivity and bring prosperity is necessary. A business requires the smooth functioning of several factors for its prosperity, such as manufacturing, marketing, etc. Accounting is one such significant factor of every business firm that provides us with detailed information regarding the existing financial condition of the firm, cash outflows as well as inflows, other financial aspects, etc. It is to be noted that accounting is a complex procedure that must be done according to various standards and principles in the county. Following the basic principles of financial accounting will provide an accurate image of the existing business scenario that can benefit different people associated with the firm, such as stakeholders, investors, and creditors.
Having an eye over the accounts of a business is crucial in the decision-making procedure, too. How business-related decisions are taken determines the fate of every business. Following accounting principles facilitates accurate decision-making by providing an actual image of the business. Moreover, it is also advantageous in data keeping, a crucial function of every business firm. In short, following the basic accounting principles provides the firm with innumerable benefits necessary for the growth of every business enterprise, especially the small businesses that wish to flourish.
What is accounting?
Although the meaning of accounting can be interpreted in various ways, one of the commonly agreed statements is that it is the process by which all the transactions related to a business are recorded. Although the accounting activities of a firm may be confined to the company, no matter whether big or small, every company is expected to follow certain common principles and practices of accounting. This is what is done by accounting principles. The meaning of accounting principle scan be referred to as some guidelines that are laid to be followed while recording the transactions. Following these principles of financial accounting provides crystal clear clarity for the financial data you have recorded in due course of time.
What are accounting principles?
Reporting a firm’s financial information regularly is necessary to function. Every country must have some commonly agreed rules and regulations to maintain a standard and structure for the financial data reported. Accounting principles refer to a set of rules or guidelines that must be followed while maintaining the financial data of an organization. The financial data prepared and recorded according to accounting principles can be easily comprehended by experts and others associated with the business field. Certain official bodies of each country decide the accounting principles or accounting standards. Regarding the case of India, the Institute of Chartered
Accountants is the official body that decides upon the accounting principles and standards.
By providing the required guidelines, the accounting principles help the accountants maintain the firm’s accounts in such a way that it has a standard structure and maintains quality. An outlook on accounting principles has become necessary for every accountant, especially those dealing with small business firms, to bring consistency and accuracy to your financial data. The owners of every small business should also consider knowing more about accounting principles to better understand what is happening within the organization regarding financial data.
What basic accounting principles should every small business owner be aware of?
As we have mentioned above in the article, it is of utmost importance that every small business owner be aware of the basic accounting principles to make better decisions in various matters of the firm. Accounting principles can be broadly divided into 14.
The fourteen accounting principles are as follows:
1. Accrual Principle
The accrual principle of accounting is the principle that provides value to a transaction’s time. According to the accrual principle, it is necessary that recording transactions, no matter how big or small, is an activity that has to be carried out during the required accounting periods. In most cases, the record-keeping must occur during the transaction period. This ensures no time lag or delay with which the transactions are recorded. On the contrary, the commonly followed practice was to record the transactions only when the actual cash flow occurs. A firm that adopts the accrual principle in accounting has to alter such commonly followed practices so that transactions and the recording of the same are events that have to take place simultaneously.
2. Conservatism Principle
Conservatism principle in accounting is the principle that gives high weightage to the accuracy of data recorded during the accounting process. It provides a guideline regarding the action that must be taken in uncertain conditions. As per the principle of conservatism, whenever there is a case of uncertainty regarding the revenue and expenditure, the revenue or income of the company can be recognized or recorded only once they are fully recovered or realized from the respective source.
On the other hand, if the uncertainty is regarding an expense or liability to be incurred, the conservatism principle suggests we record it as soon as possible. In short, per the conservatism accounting principle, the outcome with less profit should always be considered before recording the data. Following the conservatism principle in accounting is known to save taxes since taxable income is lower when this principle is implemented in financial accounting.
3. Consistency Principle
As the name suggests, the consistency principle is the one that encourages us to be consistent in one accounting method. As per the principle, if a firm adopts a specific method at the beginning of the business, it should be consistent with the method so that no switching between various methods should occur. The financial data prepared following the consistency principle is much easier to understand.
Understanding the data to arrive at meaningful conclusions and make business decisions is much easier in a firm that adopts the consistency principle in accounting. On the other hand, switching between various accounting methods in a single organization will provide us with financial data that may need to be more precise and meaningful. Thus, the consistency principle is highly preferred in organizations that wish to create transparent and meaningful financial statements.
4. Cost Principle
The cost principle refers to the mode of accounting by which the actual cost is given prime consideration in all kinds of transactions. As per the cost principle, accounting takes place in such a way that the actual cost paid is recorded in terms of cash amount while the company acquires an asset. This value remains the same and does not undergo any change with the fluctuations in the market.
Similarly, the price paid by the buyer will be recorded in such transactions. Recording transactions in terms of cost paid or received is the main idea implemented by the cost principle. The inability to bring changes according to the changing market conditions, such as inflation deflation or fluctuations in the due course of time, is considered the major drawback of the cost principle.
5. Economic Entity Principle
The economic entity principle is that principle of accounting that draws a clear line between person and business. As per this principle, a business and its owner are two separate legal and financial entities. Thus, transactions made from the part of the company and transactions done by the owner himself that are not a part of the company are two separate entities. It raises a requirement for the company’s financial transactions to be recorded separately and financial statements to be prepared accordingly. Adhering to the principle of economic entity provides an image regarding the firm’s actual financial position since the business and the owner’s transactions are not mixed up.
6. Full Disclosure Principle
Evident from the name itself, the entire disclosure principle suggests the complete disclosure of all necessary information. The hike in the transparency of accounts that a firm would experience after adopting the whole disclosure principle will be immense because all the necessary business information is represented through the company’s financial statements.
A firm that offers financial statements that are following the full disclosure principle will be greatly preferred by investors since they can make decisions quickly with the available data and information. Moreover, such firms are seen to be much more reliable, too. Generally, shareholders are much more satisfied in companies that have adopted the entire disclosure principle since they can get a clear idea of what is happening within the organization through a simple cash statement.
7. Going Concern Principle
We all are well aware of the unpredictable nature of future events, especially when it comes to the case of the business world. A company running smoothly may have to stop functioning sometimes the next day due to rapid fluctuations that can occur for any reason. However, the going concern principle in accounting must be revised and consider future unpredictable conditions. As per this policy, it is thought that the company will continue functioning for a very long period such that they will never have to stop the operations of the firm anywhere near in the future. As per this concept, the business will continue, no matter what occurs in the external environment.
8. Matching Principle
The matching principle in accounting tries to match the expenses incurred and revenue generated within a firm in a specific time frame. Thus, per this principle, the revenue generated and expense incurred have to be recorded simultaneously, creating a relationship between them. The relationship between revenue and expense can be inferred as a cause-and-effect relationship, given that both transactions occur within the same period. Since it emphasizes the recording of transactions at the time that they take place, the matching principle can also be considered a subcategory under the accrual principle of accounting.
9. Materiality Principle
The materiality principle is the one that provides importance to material items in the accounting process. The presence and absence of various material items within the business impact the overall decision-making process significantly. As per the materiality principle of accounting, a firm’s financial statements must be prepared to record all the material items within the firm correctly. Materials are given such importance since every one of them can impact the investor’s decisions.
10. Monetary Unit Principle
Similar to the principle of cost by which every transaction has to be recorded based on the cost paid or received, the monetary unit principle refers to the mode of accounting in which transactions have to be recorded only if they can be expressed in terms of monetary units such as currencies. Although the monetary unit principle is widely accepted among various firms, the major drawback of monetary unit policy is its inability to express the significance of non-quantifiable and intangible assets within a firm that plays a key role within the organization.
11. Objectivity Principle
The objectivity principle refers to the principle that relies on evidence in order to create financial statements. Adopting this principle can ensure that the financial statement is 100 percent reliable. Personal bias is considered one of the significant drawbacks of accounting principles. The objectivity principle can act as a strong tool to prevent and control biases that may otherwise creep into the financial statements. The objectivity principle is highly advantageous, especially to investors, as they can get an accurate picture of the business through financial statements that are never biased and are subject to solid evidence.
12. Reliability Principle
s we have already mentioned in this article, improving the firm’s reliability is one of the most significant advantages you can receive by adopting various accounting principles. Among these various accounting principles, the reliability principle is the one that is specific to improving reliability. Per this principle, only the information checked and verified should be represented through financial statements. Information that is checked and verified is reliable.
13. Revenue Recognition Principle
The revenue generated by the firm is the crucial factor that keeps the business running. The revenue recognition principle is a form of accrual principle that demands real-time recording of transactions. As per the suggestions provided by the revenue recognition principle, the recording of revenue to the books of account is an activity that has to take place while it is earned rather than when we receive the actual cash payment. Since the recording process is never delayed, the revenue recognition principle provides accurate information regarding the transaction, whether the outcome is profit or loss.
14. Time Period Principle
The principle of accounting that suggests that companies evaluate the performance and financial position of the firm concerning a specific time period is known as the time period principle. Thus, the business will have to divide time into specific periods, and activities within the organization must be divided accordingly. Since financial assessment has to take place after each time period, it keeps the stakeholder aware and informed about the existing scenario of the business and thereby makes better business decisions. The time period principle is also known to greatly increase the organization’s reliability.
Why is it important to follow the principles of financial accounting during the accounting process?
There are more than one or two but several reasons why you should necessarily follow the principles of financial accounting during the accounting procedure. An organization’s accounting becomes complete and best when the financial data is recorded to provide complete information regarding the organization consistently and accurately. Moreover, it must also facilitate the decision-making process by investors.
To do so, it is also necessary that the data must be comparable. All these requirements can be satisfied only if all the companies have rules or guidelines that everyone has to follow. This ensures that every firm will have a standard structure for their accounts that is easy to comprehend and compare. Thus, every firm within the country must adhere to the existing accounting principles. This will provide your firm with much more productivity as well as
Advantages of accounting principles
Following the accounting principles within your organization offers us innumerable benefits, which can be summarized below:
- Helps in adequately maintaining all the records associated with the business.
- It helps in preparing the company’s financial statements for a particular period.
- It improves the business’s transparency, making the organization more reliable for the investors.
- Accounting concerning accounting principles allows investors to compare the financial position of firms easily and invest accordingly.
- Accounting that adheres to the principles facilitates the decision-making process within the firm because decision-making is much easier if we get a clear image of the existing scenario within and outside the organization.
- It helps in taxation-related matters since these are dependent on accounts.
- Eases the entire bookkeeping procedure – The financial data is maintained with much advancement by following the accounting principles. This makes the entire process of bookkeeping much easier than before.
Disadvantages of accounting principles
As everything on this earth might have a positive as well as negative outcome, the same is applicable in the case of following accounting principles, too. Some of the disadvantages that you may face while following the accounting principles are as follows:
- Chances for bias while recording accounting information- This can affect the transparency as well as reliability of the system.
- Incurs both time and cost – Accounting under all the accounting principles requires a detailed understanding of the subject, and experts may be required to take up this process. Moreover, additional time is required to understand such principles better.
- Other limitations- The accounting principles today also have their limitations. This may affect the overall accuracy of the data.
Limitations of the existing accounting principles
As mentioned in the article, today’s accounting principles are not without defects and limitations. Thus, it is necessary to keep these limitations in mind while using financial data for decision-making, as this will provide us with a broader view of the business. Some of the limitations of accounting principles are as follows.
Inability to record the value of non-monetary items– As we all know, various non-monetary factors play a key role in determining the fate of the business. Both accounting and accounting principles need a system to record or keep track of these non-monetary items that are crucial for the business.
Inability to deal with the time value of money– It is well-known that the value of a specific amount of money fluctuates greatly with time. But, when it comes to the case of accounting principles, money is treated with a consistent value without considering the time frame. This is considered to be one of the most significant drawbacks of accounting principles.
Lack of a system that can record events that may occur in the future – Although accounting principles provide a system by which past events can be recorded in detail, there is no system by which predictions or future events that are expected to happen cannot be recorded. Thus, it is all about past events and not about the future.
Difference in the interpretation of principles– How people interpret business varies greatly. It leads to different interpretations, even for a single principle. It may affect the uniformity of financial data within various companies, whereas uniformity and a standardized structure is the primary motive for implementing accounting principles to accounting.
How do accounting principles help small businesses to flourish?
Implementing accounting principles is one of the best ways small businesses can flourish, especially in the current scenario of globalization that has resulted in high competition. Even if small companies are on the verge of profit maximization, they may need help attracting investors who can invest in the firm for its growth. This situation is attributed to various reasons, such as lack of reliability, transparency, etc.
All such issues can be quickly brought to an end by introducing accounting principles to the accounting process. Since accounting principles are well known for their ability to provide real and accurate images of the current business scenario, it becomes easy for investors to make investment decisions. Moreover, since the companies that have adopted accounting principles have their financial data more uniformly and structured, financial data is easy to compare with accounting principles. Moreover, adopting accounting principles improves the overall transparency of a firm by giving information about various transactions and related aspects, and the firm becomes reliable and accredited.
The regulatory body that sets accounting standards in India
In every country, specific organizations will be responsible for laying down the accounting standards every company must follow. Same or similar organizations are also responsible for regulating the implementation of accounting principles. In the International context, several international organizations, such as the International Accounting Standard Board (IASB) and International Financial Reporting Standards (IFRS), are the bodies that are responsible for providing such standards and governing the transactions.
However, when it comes to the case of India in particular, the Institute of Chartered Accountants of India (ICAI) is the format body responsible for governing the standards related to accounting. Although several such official bodies exist, their functioning is mainly limited to the governance of accounting standards rather than accounting principles. Although this is the case, experts strongly recommend following the accounting principles to have much more advanced bookkeeping.
How can you implement accounting principles in your firm’s accounting process?
Implementation of accounting principles in bookkeeping is known to provide a large number of benefits that are discussed below. This benefit is more likely to be significant, especially for small businesses. Thus, it is of utmost importance that small business owners should necessarily incorporate accounting principles into their accounting process. Keeping the importance of accounting principles for small businesses, several companies have developed advanced accounting services that can be utilized, especially by small business owners.
What are Accounting Solutions?
At times, firms – especially the small and medium ones may need help to recruit experts on time merely to implement accounting principles to the firm’s accounts. So, if you wish to incorporate accounting principles for your small business, the most time-saving and cost-effective method is to depend on firms that offer accounting solutions. These are firms that are known for providing accounting services for firms ranging from small to middle-sized ones. In this manner, the requirement for recruiting a specialist in the field on a full-time basis is eliminated. On the other hand, the group of experts under the accounting solutionswill provide you with the best bookkeeping possible that follows the basic principles of financial accounting.
The service rendered by accounting solutions is not limited to financial accounting alone.
Several firms offer accounting services in various disciplines, including management accounting, governmental accounting, forensic accounting, internal auditing, tax accounting, payroll accounting, etc. Here is a brief description of each type of accounting service.
l Management accounting – We all know that managers within an organization play a vital role in the overall functioning of an organization and have a significant role in decision-making. Management accounting refers to the branch of accounting that renders the organization’s managers with the required financial data and information, which can help adopt proper management practices within the organization.
Governmental accounting – As the name suggests, governmental accounting, also called public accounting, refers to the accounting procedure in which public revenue is the subject. Governmental accounting is the one that is responsible for keeping track of the income and how it is spent on various policies and other activities.
Forensic accounting – Forensic Accounting refers to the practice by which various principles and practices associated with accounting are put to use to find forensic crimes. Forensic accountants are the ones who are qualified to take up forensic accounting.
Internal auditing – Internal auditing refers to auditing financial information within the organization so that any financial mistakes or fraud can be diagnosed and prevented. This is necessary to ensure that such mistakes do not creep into financial statements while preparing them. Internal auditing is of great importance in the proper running of every business organization.
Tax accounting – Tax accounting is the one that has to deal with all formalities associated with the tax of an organization. Proper tax accounting is required to file taxes on time to prevent legal penalties.
Payroll accounting – Providing proper remuneration to the employees is necessary in keeping high morale among them. But, it is equally essential for the company to keep track of the workers’ payroll and related documents. Payroll accounting is associated with the accounting of payroll of employees. Proper payroll accounting ensures that remuneration is provided to the employees in accordance with the guidelines and rules of the government.
Conclusion
As we have discussed throughout the article, following accounting standards during the accounting procedure will help in the upliftment of any small business firm. In case you worry about the extra cost that would be incurred, there is no requirement for such a worry because a large number of expert firms are available whom you can depend on for this purpose. The advantage that one can have with accounting principles is that they are flexible when compared to formal accounting standards. Although that is the case, sticking to accounting principles can provide a uniform structure to your financial data devoid of mistakes to the maximum.
Understanding the accurate financial position of the firm has become necessary to carry out the business forward, especially for the small and medium entrepreneurs who strive to stay in the highly competitive ground of business. No matter how much effort we put in, gaining the trust of investors as well as customers of the firm is always worthwhile. Adopting accounting principles is the one-stop solution for all such issues, as this will create a perfect and transparent financial system.
