One of the most important aspects of owning a business is understanding accounting concepts. These concepts are essential for making informed financial decisions and ensuring the long-term success of your company. In this article, we shall discuss 10 accounting concepts that every business owner should know. We will explain what each concept means and provide examples to help you understand, how they can be applied in the real world.
What are Accounting Concepts?
Accounting concepts are the fundamental ideas, assumptions and statements of accounting theory that provide a framework for financial accounting. These principles are designed to ensure that financial statements will be prepared in a consistent manner. When this happens it will be easier to compare different businesses’ performance as well as their position over time. This could help a lot when it comes to making important business decisions.
How many Accounting Concepts are there?
There are ten main accounting concepts, or principles of accounting that we will discuss in this article: the going concern concept, accrual basis of accounting, revenue recognition principle, matching principle, full disclosure principle, conservatism principle, materiality principle, income measurement objective and cost-benefit analysis.
The Going Concern Concept
The going concern concept assumes that the business will continue to operate for the foreseeable future and is not about to be shut down. This means that in preparing financial statements of an organization, accountants assume that all assets are long-term in nature, which can be used by the company over a period of time, and as such should not be valued at their liquidation value.
Accrual Basis of Accounting
The accrual basis of accounting is the recognition of revenue and expenses when it is earned and incurred, respectively, regardless of when the actual cash transactions take place. For example, if a company has provided services but has not yet received payment from the customer, the company would still recognize the revenue on its books. This is done because it better reflects the financial performance of the company.
Revenue Recognition Principle
This is one of the principles of accounting that requires that revenue be recognized when it is realized or realizable based on its certainty. In other words, revenue should be recognized when the sale has been made and delivered to the customer and payment from such customer is certain that it shall not be a bad debt, regardless of whether payment is received at that time or not.
Matching Principle
The matching principle requires that all expenses related to the acquisition of revenue in a given period of time be recorded in the same accounting period as that revenue. For example, if a company pays for advertising in March, but sees its sales increase in April, the advertising expense would be included in the April financial statements.
Full Disclosure Principle
The full disclosure principle requires that all material information is disclosed in the financial statements. Material information includes all that could potentially impact the decision of a reader of those statements, such as investors, lenders, creditors and other stakeholders.
Conservatism Principle
The conservatism principle requires that accountants record expenses as soon as possible in the accounting period, but record revenues only when they are realized. As a result of this principle, accountants tend to be more conservative in their reporting, preferring to err on the side of caution.
Materiality Principle
The materiality principle states that only information that is material to the decision of a stakeholder should be disclosed in an organization’s financial statements. This is subjective and depends on the situation, but generally speaking, information that is not material can be left out of the financial statements.
Income Measurement Objective
The income measurement objective requires that the income of an entity be measured in a manner that is accurate and consistent over time. This is done by using accounting standards such as GAAP and IFRS.
Cost-Benefit Analysis
The cost-benefit analysis is a concept whereby the costs of implementing a particular accounting standard or procedure are weighed against the benefits. If the benefits outweigh the costs, then it may be more beneficial for an organization to implement that standard or procedure.
These are just some of the more important accounting concepts that every business owner should be familiar with. By understanding these concepts, you will be better equipped to make sound financial decisions for your business.
What are the Different Methods of Accounting?
There are three main accounting methods: Accrual basis, Cash basis, and Modified cash basis.
- The accrual method is the most commonly used accounting method and it requires businesses to record revenues at the time they are earned and expenses at the time they are incurred
- This method is superior to cash accounting, as it provides a more complete picture of profits and losses during a given period
- Cash accounting basis is the simplest form of accounting and it only records revenues when cash is received and expenses when cash is paid.
- The modified cash basis is a combination of the cash and accrual methods
- It records revenues when they are earned and paid, but expenses are only recorded when cash is paid
Conclusion
In order to make sound financial decisions for your business, it’s important to have a strong understanding of accounting concepts. These 10 concepts are a great place to start. And if you’re looking for additional education on accounting and finance, our online courses are perfect for students of all levels of experience.
