The Four Accounting Principles Every Business Owner Should Understand

As a business owner, you know that accounting is the backbone of your business. Without it, you don't have the information necessary to make good business decisions that will drive the company forward. With that said, learning the basic accounting principles will give you even more understanding behind the numbers.

Accounting is considered a science due to its organized and systematic methods for recording, classifying, and summarizing financial transactions. And, within every science, there are principles that create the groundwork and guide the processes to ensure there is reliable information to work from.

The following accounting principles form the foundation of Generally Accepted Accounting Principles (GAAP) and are essential for providing accurate financial statements that are comparable across reporting periods:

Accrual Principle-You have probably heard the term accrual or cash basis accounting in your business life (i.e. your taxes are filed either by the accrual or cash basis method). But, there is more to it than just filing a tax return as it will help you determine how the business is actually performing.

The accrual principle stipulates that revenues and expenses should be recognized in the period in which they are earned or incurred, regardless of when the related cash transactions occur. For instance, revenue should be recorded when goods are delivered or services rendered, even if payment has not yet been received. This method assures that the revenue is recognized when it actually happens and is why the Accounts Receivable account exists on the Balance Sheet.

Accruals occur on the payable side also for expenses incurred in a certain period but not yet billed for. Again, an accrual brings the expense in to the correct period.

Matching Principle-Under the matching principle, expenses must be recorded in the same accounting period as the revenues they help to generate. This alignment ensures that financial performance is accurately reflected and that income statement presents a true picture of the profitability of a business during a given period.

In order to match expenses and revenues, accruals, as discussed above, should be used.

Materiality Principle-The materiality principle requires that all information likely to influence the decisions of users of financial statements, be fully disclosed. An item is considered material if its omission or misstatement could affect economic decisions made by stakeholders based on those financial reports.

Point being, if a dollar amount affects the way a user of the financial statements interprets the information, the transaction needs to be included in the books. Inversely, being pennies off in a reconciliation is not material and one shouldn't spend hours trying to figure out the difference as the amount is immaterial.

Consistency Principle-The consistency principle mandates that a company apply the same accounting methods and procedures from one period to the next. This enables users to make meaningful comparisons of financial data over time and safeguards the reliability of a variance analysis.

A variance analysis is a good example of how this accounting principle comes into play. If we are measuring the difference between this year's and last year's income statement, we want to make sure the same methods are being used to be able to determine why the differences occurred. For example, if you are looking at rent expense and last year your accountant used accruals, but did not in the current year, and should have, there would be a difference between the years which may lead you to believe the rent went up or down when, in reality, it didn't.

Accounting principles are the pillars that all of accounting is built upon and gives us the best information possible to use the financial statements as an effective guide to growing the business.

Golden Pathway Accounting

Managing Director Golden Pathway Accounting