Basic Accounting Principles

What are Basic Accounting Principles?

Whether you intend to do your own bookkeeping or you plan to pay someone else to do it for you, an understanding of basic principles of accounting will help you to understand your bookkeeping reports.

The Accounting Entity Assumption

If an accountant or a bookkeeper is to record, classify and summarize the transactions of a business in the financial statements, he or she must be able to identify clearly the boundaries between the business and the business owner.

Under the accounting entity assumption, the business is considered to be a separate entity from its owner (even for sole trader businesses).

It is assumed that each entity owns it assets and incurs its own liabilities, and the assets, liabilities, and business activities of the business are kept completely separate from those of the owner.

This assumption is particularly important for small business owners as there is a tendency to blur the lines between the business and themselves, often to their detriment financially. If your accountant or bookkeeper has to spend time sorting through your records to identify what relates to the business and what relates to you personally it will cost you!

The Cost Principle

The resources of a business are initially recorded at their cost under the cost principle. Cost is calculated as the price paid plus any other expenses incurred for the delivery or set-up of the resource.

In reading a balance it pays to remember this principle as the dollar values reported in the balance sheet are the original cost rather than an indication of the current market value.

The Going Concern Assumption

Financial Statements are prepared on the assumption that the business will continue to operate in the future.

The Period Assumption

The financial performance of a business is measured in terms of the net profit calculated over a fixed period of time. This principle basically divides the life of the business into equal intervals of time, because of statutory requirements the reporting period is generally a twelve month period.

The Objectivity Assumption

This assumption assumes that accounting data must be reported i an objective or factual basis. This also offers an explanation for the cost principle, as recording assets at cost allows a certain degree of stability or certainty about the data. Current market values are based on estimates, appraisals or opinions, whereas the original cost is factual data.

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