These eight accounting principles are what guide the integrity of your bookkeeping. Economic Entity Assumption This assumption means that the business is its own separate entity, distinct from its owners. It reminds us that we must keep the business's financial activities completely separate from any personal finances.
Business and personal expenses are like oil and water—they should never mix!
Reliability Assumption This principle ensures that the information you record in your financial documents is verifiable and backed by proper documentation. If you can't provide an invoice, receipt, or bank statement to support a transaction, it is not a reliable transaction and can't be recorded.
Full Disclosure principle This principle states that any information lenders or investors might need to make informed decisions should be disclosed in the financial statements or accompanying notes.
For example, if a worker files a worker's compensation claim, it's essential to include that information in the notes of the financial statements.
Conservatism Assumption
When you are not sure if or how to record an item, this principle guides us to err on the side of caution. It means we choose options that show less income or asset benefit. Potential losses can be recorded, while potential gains cannot.
For instance, if your business is facing a potential lawsuit, you can consider it a loss and note it. But, if your business is expecting increased foot traffic to their business due to a new business opening nearby, you can't record a potential gain until it actually happens. Better to be cautious than overly optimistic.
Materiality Principle This principle allows you to focus on what really matters. It states that if an accounting standard has such a small impact on the financial statements that it wouldn't mislead anyone, you can ignore it.
Take rounding, for example. When recording documentation, we often round amounts to the nearest whole dollar instead of fussing over cents.
Use caution when applying this principle. Determining materiality can be highly subjective. When in doubt, seek advice from colleagues or an accountant who can provide valuable insights.
Consistency Principle Once a business adopts a specific accounting method for recording certain items, it commits to entering all similar items in the same way in the future. This principle applies to line items on all financial statements and reports.
Imagine you hire a new bookkeeper to take over for a previous bookkeeper who handled depreciation calculations differently than your new bookkeeper typically does. If your new bookkeeper were to introduce a new method, the expense figures might look different on the statements even though there wasn't an actual change in your businesses financial situation.
Instead, by adhering to the consistency principle, you maintain continuity and comparability in your businesses financial records. You would only change an accounting method if the new version improves the accuracy of reporting.
Monetary Unit Assumption This assumption brings simplicity and uniformity to your accounting practices. It states that you use one currency throughout all of your accounting activities. In the United States, that currency is the US dollar.
You don't need to worry about inflation or changes in currency values when recording your business finances. For instance, if your business purchased a piece of land and the value has increased over time, you don't need to adjust the recorded value based on the current market price. Just stick to the price paid at the time of purchase. This assumption keeps records straightforward and avoids the complication of fluctuating values.
Going Concern Assumption This principle assures us that the business is stable enough to operate and meet its obligations for the foreseeable future. The business acts and makes decisions with the intention of continuing to run the business rather than liquidating it.
If and when a business is in danger of failing and is no longer considered a going concern, it's essential to report the issues it is facing, such as ongoing losses, credit denials, or lawsuits. Transparency is critical in these situations.
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