Here are a few of the principles, assumptions, and
concepts that provide guidance in developing GAAP. The procedural part of accounting—recording transactions right
through to creating financial statements—is a universal process. Businesses all around the world carry out this process as part of
their normal operations. In carrying out these steps, the timing
and rate at which transactions are recorded and subsequently
reported in the financial statements are determined by the accepted
accounting principles used by the company. You also learned that the SEC is an independent federal agency
that is charged with protecting the interests of investors,
regulating stock markets, and ensuring companies adhere to GAAP
requirements.

• If there is no revenue caused by an expense, the expense is recorded when incurred.
• The customer did not pay cash for the service at that time and was billed for the service, paying at a later date.
• Dividends paid to shareholders also have a normal balance
  that is a debit entry.
• Cost Benefit Principle – limits the required amount of research and time to record or report financial information if the cost outweighs the benefit.

The ending account balance is found by calculating the difference between debits and credits for each account. You will often see the terms debit and credit represented in shorthand, written as DR or dr and CR or cr, respectively. We can illustrate each account type and its corresponding debit and credit effects in the form of an expanded accounting equation. You will learn more about the expanded accounting equation and use it to analyze transactions in Define and Describe the Expanded Accounting Equation and Its Relationship to Analyzing Transactions. Recall that the accounting equation can be thought of from a “sources and claims” perspective; that is, the assets (items owned by the organization) were obtained by incurring liabilities or were provided by owners. Some companies that operate on a global scale may be able to report their financial statements using IFRS.

Revenue Recognition Principle

For example, in 2014, the FASB and the IASB jointly announced new revenue recognition standards. Financial statements identify their unit of measure (such as the dollar in the United States) so the
statement user breakeven point bep definition can make valid comparisons of amounts. For example, it would be difficult to compare
relative asset amounts or profitability of a company reporting in US dollars with a company reporting
in Japanese yen.

• The concept of the T-account was briefly mentioned in Introduction to Financial Statements and will be used later in this chapter to analyze transactions.
• Without a monetary unit, it would be impossible to add such
  items as buildings, equipment, and inventory on a balance sheet.
• The most notable principles include the revenue recognition principle, matching principle, materiality principle, and consistency principle.

Even though the customer has not yet paid cash, there is a reasonable expectation that the customer will pay in the future. Since the company has provided the service, it would recognize the revenue as earned, even though cash has yet to be collected. Accounting concepts and principles are a set of rules and assumptions that are necessary to set a standard while recording financial transactions as well as maintaining books of accounts in the business. The going concern principle assumes that a company will continue to operate indefinitely unless there is substantial evidence to the contrary.

Cost principle.

These critics claim having strict rules means that companies must spend an unfair amount of their resources to comply with industry standards. This makes it easier for investors to analyze and extract useful information from the company’s financial statements, including trend data over a period of time. It also facilitates the comparison of financial information across different companies. Accounting principles also help mitigate accounting fraud by increasing transparency and allowing red flags to be identified.

Historical Cost Principle

Any rule can be justified objectively if it is based on accurate figures and facts. This principle dictates that revenue should be recognised when it is both earned and realisable. It ensures that revenue is not prematurely recognised and reflects the actual value a company has generated.

5: Describe Principles, Assumptions, and Concepts of Accounting and Their Relationship to Financial Statements

The revenue recognition principle directs a company to recognize revenue in the period in which it is earned; revenue is not considered earned until a product or service has been provided. This means the period of time in which you performed the service or gave the customer the product is the period in which revenue is recognized. A potential or existing investor wants timely information by which to measure the performance of the company, and to help decide whether to invest.

Let’s say there were a credit of $4,000 and a debit of $6,000 in the Accounts Payable account. Since Accounts Payable increases on the credit side, one would expect a normal balance on the credit side. However, the difference between the two figures in this case would be a debit balance of $2,000, which is an abnormal balance.

The primary exceptions to this historical cost treatment, at this time, are financial instruments, such as stocks and bonds, which might be recorded at their fair market value. As you may also recall, GAAP are the concepts, standards, and rules that guide the preparation and presentation of financial statements. The periodicity assumption requires preparing adjusting entries under the accrual basis. Without
the periodicity assumption, a business would have only one time period running from its inception to
its termination.