10 Basic Principles of Accounting to Better Understand Your Finances

Accounting is more than just a complex mathematical discipline used for business. In fact, accounting is a crucial life skill that you’ll also need to understand your personal finances, as well as get your financial ducks in a row if you ever want to launch a small business. But practicing accurate accounting is easier said than done. You can make sure you keep accurate records and fully grasp your finances before making any big economic decision by following some of the basic principles of accounting. What exactly are those? Let’s examine 10 basic accounting principles in more detail below.

Why Are Accounting Principles Important?

You can think of accounting principles as standards or guidelines that accountants and business owners should strive to adhere to all the time. They’re important standards since they can help accountants keep accurate records that can be easily analyzed and reviewed by other accountants or auditors, such as the IRS. It's important for business owners to adhere to accounting principles as well since it will help you keep better records of your expenses and revenue. This will, in turn, also make it easier for you to make smart business decisions regarding the future of your company. More personally, you can utilize many of the basic principles of accounting to understand your financial situation a little better. For instance, certain accounting principles can help you determine:

• If it’s a good idea to take out another credit card
• How well you are controlling your expenses
• Keep track of necessary or frivolous expenses when building a budget
• ...and more!

The GAAP and Your Business

Alongside “basic” accounting principles, there are the generally accepted accounting principles or GAAP. This is the official collection of the most important accounting principles in the industry. But the GAAP is important not just because of its financial assistance. These principles are crucial if you want your business to ever be traded publicly on the stock market or if you want other businesses to trust your financial reports. In a way, the GAAP is a widely recognized set of standards that, if everyone agrees to follow them, helps to maintain fair and accurate trade throughout the market. Even if your company isn’t publicly traded, you may still need to adhere to the GAAP wherever it’s applicable in order to take out certain favorable loans .

10 Most Important Accounting Principles for Your Financial Well-Being

The GAAP is a pretty big collection of accounting principles. We’ll go over the 10 most important basic accounting principles that you can use for day-to-day accounting needs and for managing your own finances.

Cost Principle

The cost principle is one of the most basic and important accounting principles you can know. “Cost”, of course, refers to how much money you spent when you originally obtained that item or asset. It doesn’t matter if you bought it yesterday or a few years ago. This helps you keep an accurate accounting of all of your company's expenses, not how much an item costs you now. This does result in expense amounts not being adjusted for inflation. But the cost principle can be helpful when looking at your finances and determining how much money you’ve spent over a longer period of time, such as many years.

Matching Principle

The matching principle states that all companies should use the accrual basis of accounting. In other words, you should match all of your expenses with revenues. For instance, any sales commission expenses should be reported in the same timeframe when the associated sales were made. For another example, any employee wages should be reported as expenses in the same week when the employees worked. This helps you to keep better records for your business and will assist with any future audits.

Revenue Recognition Principle

This principle is related to the above and states that you should recognize all of your revenue as soon as you perform a service or sell a product. In other words, recognize or report your revenue even if you haven’t received the money in your actual bank account yet. Again, this helps you keep an accurate record of your real revenue and expenses, especially since certain payments can be delayed.

Expense Principle

The expense principle states that you should record any expense as soon as you use goods or receive services that you have paid for. This prevents your accountant from delaying the reporting of expenses, which can lead to an incomplete picture of your business’s overall financial situation.

Objectivity Principle

The objectivity principle is pretty straightforward. It states that business owners and accountants should be objective when reporting information.

Monetary Unit Principle

Then there’s the monetary unit principle. In a nutshell, this principle means that all of your transactions should be measured in actual currencies or units. Most of the time, this will be in U.S. dollars, but if you do international business you should still keep all of your records with real currency measurements. This prevents your books from having abstract or vague units of currency take the place of real cash. For example, if you’re a small business owner, you shouldn’t record “a favor” as a unit of currency.

Conservatism Principle

The conservatism principle will help accountants keep a tight ship in terms of bookkeeping . In a nutshell, it requires accountants to, in a situation where there are two possible alternatives when reporting a line item, choose the item that will result in less net income.

Going Concern Principle

The going concern principle just means that you should act and record transactions as though your company will keep existing for the foreseeable future. Business owners often do this to defer some prepaid expenses. But it also prevents you from accidentally taking big expenses into account for no reason, such as when you won't realistically pay those costs until much later. The only exception to this principle is if a company is about to be liquidated, in which case the acting accountant should disclose this information in any assessment.

Materiality Principle

The materiality principle essentially allows accountants to violate any other accounting principle if a given amount is deemed insignificant enough. This necessarily requires some good personal judgment, so only trained accountants or CPAs should practice this principle.

Full Disclosure Principle

The full disclosure principle is incredibly important even though it's a little commonsensical. Basically, it states that any important information necessary to understand a financial statement should also be included within the financial statement itself, or at least in its footnotes. This prevents accountants and business owners from having to look through multiple financial documents to understand a single paper. For example, a company might be involved in a lawsuit with another company that is demanding lots of money. Financial statements should be prepared to state clearly that the company can or cannot defend itself so that accountants and lawyers don't have to make further inquiries. The full disclosure principle helps companies to remain transparent with each other and facilitates good commercial transactions.

Common Sense Principles for Understand Your Finances

The above principles are great standards and practices for trained accountants to adhere to. But what about understanding your own finances? Many of the above principles have nuggets of common sense or wisdom that you can easily apply when balancing your checkbook or keeping basic finances for your family.

• For example, it’s always a good idea to record information accurately and as soon as you receive it. In accordance with the above principles, don’t record any revenue or income that you haven’t actually earned yet (i.e. don’t assume you’ll make the same amount of money next month as you did this month while working as a freelancer).
• Similarly, record any expenses as soon as you make them. Don’t wait to balance your books in terms of your monthly expenses at the end of the month, when it’s more likely you’ll forget something.
• Don’t let hopes and dreams cloud your unbiased accounting analysis. When balancing your checkbook or planning your financial future, you should try to remain objective and conservative if possible.
• Record any expenses as they originally were priced, not how much they cost now.
• Try to match all of your expenses with revenue. Don't report the income you make from expenses separately. By matching your expenses with revenue, you’ll be able to better track how much your net profit is.

Summary

All in all, everyone can benefit from following certain basic accounting principles, whether they’re part of the GAAP or just derived from common sense. Better accounting will help us all make better financial decisions in the future and avoid taking on too much debt. For all your other questions, or for further financial advice, don't hesitate to contact Seek Capital . Our financial experts are well-equipped to help you with all things business financing ! Sources https://www.investopedia.com/terms/g/gaap.asp https://www.accountingtools.com/articles/2017/5/14/the-materiality-principle https://www.aicpa-cima.com/designations-certifications/certified-public-accountant-cpa.html#:~:text=Certified%20Public%20Accountant%20(CPA)&text=The%20CPA%20designation%20distinguishes%20licensed,the%20financial%20health%20of%20organizations .