8as|c Account|ng r|nc|p|e What It Means |n

ke|at|onsh|p to a I|nanc|a| Statement

1 Lconom|c Lnt|ty Assumpt|on
1he accountant keeps a|| of the bus|ness
transact|ons of a so|e propr|etorsh|p separate from
the bus|ness owners persona| transact|ons Ior
|ega| purposes a so|e propr|etorsh|p and |ts owner
are cons|dered to be one ent|ty but for account|ng
purposes they are cons|dered to be two separate
ent|t|es

2 Monetary Un|t Assumpt|on
Lconom|c act|v|ty |s measured |n US do||ars and
on|y transact|ons that can be expressed |n US
do||ars are recorded

8ecause of th|s bas|c account|ng pr|nc|p|e |t |s
assumed that the do||ars purchas|ng power has not
changed over t|me As a resu|t accountants |gnore
the effect of |nf|at|on on recorded amounts Ior
examp|e do||ars from a 1960 transact|on are
comb|ned (or shown w|th) do||ars from a 2010
transact|on

3 1|me er|od Assumpt|on
1h|s account|ng pr|nc|p|e assumes that |t |s poss|b|e
to report the comp|ex and ongo|ng act|v|t|es of a
bus|ness |n re|at|ve|y short d|st|nct t|me |nterva|s
such as the f|ve months ended May 31 2010 or the
S weeks ended May 1 2010 1he shorter the t|me
|nterva| the more ||ke|y the need for the
accountant to est|mate amounts re|evant to that
per|od Ior examp|e the property tax b||| |s
rece|ved on December 1S of each year Cn the
|ncome statement for the year ended December 31
2010 the amount |s known but for the |ncome
statement for the three months ended March 31
2010 the amount was not known and an est|mate
had to be used

It |s |mperat|ve that the t|me |nterva| (or per|od of
t|me) be shown |n the head|ng of each |ncome
statement statement of stockho|ders equ|ty and
statement of cash f|ows Labe||ng one of these
f|nanc|a| statements w|th December 31 |s not
good enoughthe reader needs to know |f the
statement covers the one week end|ng December
31 2010 the month end|ng December 31 2010 the
three months end|ng December 31 2010 or the
year ended December 31 2010

4 Cost r|nc|p|e
Irom an accountants po|nt of v|ew the term cost
refers to the amount spent (cash or the cash
equ|va|ent) when an |tem was or|g|na||y obta|ned
whether that purchase happened |ast year or th|rty
years ago Ior th|s reason the amounts shown on
f|nanc|a| statements are referred to as h|stor|ca|
cost amounts

8ecause of th|s account|ng pr|nc|p|e asset amounts
are not ad[usted upward for |nf|at|on In fact as a
genera| ru|e asset amounts are not ad[usted to
ref|ect any type of |ncrease |n va|ue nence an
asset amount does not ref|ect the amount of
money a company wou|d rece|ve |f |t were to se||
the asset at todays market va|ue (An except|on |s
certa|n |nvestments |n stocks and bonds that are
act|ve|y traded on a stock exchange) If you want to
know the current va|ue of a companys |ongterm
assets you w||| not get th|s |nformat|on from a
companys f|nanc|a| statementsyou need to |ook
e|sewhere perhaps to a th|rdparty appra|ser

S Iu|| D|sc|osure r|nc|p|e
If certa|n |nformat|on |s |mportant to an |nvestor or
|ender us|ng the f|nanc|a| statements that
|nformat|on shou|d be d|sc|osed w|th|n the
statement or |n the notes to the statement It |s
because of th|s bas|c account|ng pr|nc|p|e that
numerous pages of footnotes are often attached
to f|nanc|a| statements

As an examp|e |ets say a company |s named |n a
|awsu|t that demands a s|gn|f|cant amount of
money When the f|nanc|a| statements are
prepared |t |s not c|ear whether the company w|||
be ab|e to defend |tse|f or whether |t m|ght |ose the
|awsu|t As a resu|t of these cond|t|ons and because
of the fu|| d|sc|osure pr|nc|p|e the |awsu|t w||| be
descr|bed |n the notes to the f|nanc|a| statements

A company usua||y ||sts |ts s|gn|f|cant account|ng
po||c|es as the f|rst note to |ts f|nanc|a| statements
6 Go|ng Concern r|nc|p|e
1h|s account|ng pr|nc|p|e assumes that a company
w||| cont|nue to ex|st |ong enough to carry out |ts
ob[ect|ves and comm|tments and w||| not ||qu|date
|n the foreseeab|e future If the companys f|nanc|a|
s|tuat|on |s such that the accountant be||eves the
company w||| not be ab|e to cont|nue on the
accountant |s requ|red to d|sc|ose th|s assessment

1he go|ng concern pr|nc|p|e a||ows the company to
defer some of |ts prepa|d expenses unt|| future
account|ng per|ods

7 Match|ng r|nc|p|e
1h|s account|ng pr|nc|p|e requ|res compan|es to use
the accrua| bas|s of account|ng 1he match|ng
pr|nc|p|e requ|res that expenses be matched w|th
revenues Ior examp|e sa|es comm|ss|ons expense
shou|d be reported |n the per|od when the sa|es
were made (and not reported |n the per|od when
the comm|ss|ons were pa|d) Wages to emp|oyees
are reported as an expense |n the week when the
emp|oyees worked and not |n the week when the
emp|oyees are pa|d If a company agrees to g|ve |ts
emp|oyees 1 of |ts 2010 revenues as a bonus on
Ianuary 1S 2011 the company shou|d report the
bonus as an expense |n 2010 and the amount
unpa|d at December 31 2010 as a ||ab|||ty (1he
expense |s occurr|ng as the sa|es are occurr|ng)

8ecause we cannot measure the future econom|c
benef|t of th|ngs such as advert|sements (and
thereby we cannot match the ad expense w|th
re|ated future revenues) the accountant charges
the ad amount to expense |n the per|od that the ad
|s run

(1o |earn more about ad[ust|ng entr|es go to
Lxp|anat|on of Ad[ust|ng Lntr|es and Dr|||s for
Ad[ust|ng Lntr|es)

8 kevenue kecogn|t|on r|nc|p|e
Under the accrua| bas|s of account|ng (as opposed
to the cash bas|s of account|ng) revenues are
recogn|zed as soon as a product has been so|d or a
serv|ce has been performed regard|ess of when the
money |s actua||y rece|ved Under th|s bas|c
account|ng pr|nc|p|e a company cou|d earn and
report 520000 of revenue |n |ts f|rst month of
operat|on but rece|ve 50 |n actua| cash |n that
month

Ior examp|e |f A8C Consu|t|ng comp|etes |ts serv|ce
at an agreed pr|ce of 51000 A8C shou|d recogn|ze
51000 of revenue as soon as |ts work |s done|t
does not matter whether the c||ent pays the 51000
|mmed|ate|y or |n 30 days Do not confuse revenue
w|th a cash rece|pt

9 Mater|a||ty
8ecause of th|s bas|c account|ng pr|nc|p|e or
gu|de||ne an accountant m|ght be a||owed to
v|o|ate another account|ng pr|nc|p|e |f an amount |s
|ns|gn|f|cant rofess|ona| [udgement |s needed to
dec|de whether an amount |s |ns|gn|f|cant or
|mmater|a|

An examp|e of an obv|ous|y |mmater|a| |tem |s the
purchase of a 51S0 pr|nter by a h|gh|y prof|tab|e
mu|t|m||||on do||ar company 8ecause the pr|nter
w||| be used for f|ve years the match|ng pr|nc|p|e
d|rects the accountant to expense the cost over the
f|veyear per|od 1he mater|a||ty gu|de||ne a||ows
th|s company to v|o|ate the match|ng pr|nc|p|e and
to expense the ent|re cost of 51S0 |n the year |t |s
purchased 1he [ust|f|cat|on |s that no one wou|d
cons|der |t m|s|ead|ng |f 51S0 |s expensed |n the
f|rst year |nstead of 530 be|ng expensed |n each of
the f|ve years that |t |s used

8ecause of mater|a||ty f|nanc|a| statements usua||y
show amounts rounded to the nearest do||ar to the
nearest thousand or to the nearest m||||on do||ars
depend|ng on the s|ze of the company

10 Conservat|sm
If a s|tuat|on ar|ses where there are two acceptab|e
a|ternat|ves for report|ng an |tem conservat|sm
d|rects the accountant to choose the a|ternat|ve
that w||| resu|t |n |ess net |ncome and]or |ess asset
amount Conservat|sm he|ps the accountant to
break a t|e It does not d|rect accountants to be
conservat|ve Accountants are expected to be
unb|ased and ob[ect|ve

1he bas|c account|ng pr|nc|p|e of conservat|sm
|eads accountants to ant|c|pate or d|sc|ose |osses
but |t does not a||ow a s|m||ar act|on for ga|ns Ior
examp|e potent|a| |osses from |awsu|ts w||| be
reported on the f|nanc|a| statements or |n the
notes but potent|a| ga|ns w||| not be reported
A|so an accountant may wr|te |nventory down to
an amount that |s |ower than the or|g|na| cost but
w||| not wr|te |nventory up to an amount h|gher
than the or|g|na| cost