Understanding Accounting Principles

This assignment delves into the foundational principles of accounting, emphasizing their importance in ensuring reliable and comparable financial statements. It examines the principles of consistency, matching, materiality, and substance over form. The assignment particularly highlights challenges associated with revenue recognition, especially in complex scenarios involving long-term projects or bundled goods and services. It stresses the significance of adhering to these principles for accurate financial reporting.

Accounting Principles

Table of Contents
INTRODUCTION...........................................................................................................................1
LITERATURE REVIEW................................................................................................................2
The definition of Accounting Principles and its relevance in Accounting..................................3
Accounting Principles contribution to the development of accounting theory............................4
The effects of the term in the Conceptual Framework of Accounting.........................................8
The issues and controversies of the accounting principles in accounting practice....................10
CONCLUSION..............................................................................................................................12
SCIENTIFIC SOURCES AND REFERENCES...........................................................................13

INTRODUCTION
Accounting is the process that constitutes of measurement, processing, interpretation and
communicating financial data about the entities to all the stakeholders through publishing audited
reports. In other words, a systematic procedure by which companies identify, record, classify,
summarize, verify and interpret their financial results is called financial accounting. In order to
record transactions properly, accountant require to adhere with certain pre-specified Generally
Accepted Accounting principles (GAAP). These are just the guidelines and rules that are
essential to be complied while preparing different accounts such as profitability statement,
balance sheet, cash flow statement and others. All the GAAPs are domestic accounting standard
and not the universally accepted and many-times, also referred as concepts, accounting policies
and rules. With the internationalization and changing market need and circumstances, these
principles are also changed constantly in line with the market forces. Hence, these are flexible
rule rather than rigid. Historical cost accounting, matching, revenue recognition, conservatism,
materiality, objectivity, profit and loss recognition and full disclosure are some of the most
significant principles which accountant follows under financial accounting. The thrust of the
research study is to make detailed examination of various key principles and its contribution in
developing accounting theory. Moreover, all these set of principles are subjected to various
controversies which also will be examined thoroughly.
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LITERATURE REVIEW
Literature review is the process of extracting useful information about the given problem
using the secondary sources like academician’s researches, scholarly articles and other sources. It
is used collecting various author’s view-point, opinion and study findings. Thorough assessment
of number of literatures enable researcher to determine research gap and develop conceptual
framework for researcher’s own study. There are number of studies carried out by the
investigator to examine various key accounting principles and guidelines that an accountant must
follow while making their financial accounts.
The current section targets depth fully analysis of multiple of GAAPs in pre-historic
development period (1400-1800), pragmatic accounting (1800-1955), normative accounting
(1956-1970) and positive accounting (1950-present day). It mainly focuses on principles
including historical cost account wherein transactions are recorded at historical cost. Moreover,
transactions can be recorded following either accrual basis or cash basis, thus, both the principles
will be analyzed in matching principle. In addition to this, principle of substance, conservatism,
gain or loss identifying, materiality, objective and full disclosures will be evaluated to present all
the results in the financial accounts. It is important to inform all the stakeholders such as
shareholders, creditors, lenders, workers and others for decision-making purpose. Moreover, how
all these principles leads to development of conceptual framework of financial accounting had
analyzed. Although, the principles provides comprehensive details in the accounts, still, at the
same time, these all have number of limitations and downfall side. Thus, finally, the study
evaluates that key drawbacks associated with each of the accounting principles discussed in the
study for preparation of financial reports.
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The definition of Accounting Principles and its relevance in Accounting
Accounting principles are general rules governing the development of accounting
methods and are derived from the objectives of financial statements, theoretical concepts and
accounting assumptions.So the accounting principles are generalizations or general guidelines
for what the accountant must follow in a given situation. It has been developed over the years to
be used as a practical tool to help solve accounting problems, and it is comprehensive,
appropriate and suitable for use in most economic.
These principles - contrary to the laws of sport and science - are not scientifically
derived, so they are constantly reviewed and revised to comply with the economic environment
surrounding their application and use.
The financial statements are prepared in accordance with generally accepted accounting
principles and principles accepted by the practitioners of the accounting profession, which gives
reassurance to all parties concerned with the affairs of the economic establishment in terms of
the validity, fairness, and objectivity of these financial statements.They include both concepts,
customs and basic accounting judgments, which are the whole practical application of
accountants.
The preparation of the financial statements and their submission to the benefit of their
users especially by the external parties requires the accountant to know the accounting principles
in which the process of accounting measurement, and that the decision makers of information
users should have a clear understanding of accounting principles, and a good understanding of
what is presented to them from terms and words, since accounting is the language of business,
and that language may differ in its meaning from the common and common meaning among
people in their daily lives.
However, that should be noted, the so-called "accepted accounting principles" are not
universally accepted by the book of accounting. There are so-called "accounting principles",
some of which refer to them as "concepts, principles or accounting policies ", some might call"
accounting rules ".
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These "accounting principles ", or "generally accepted accounting principles", are
characterized as man-made, not rigid rules, and therefore it subject to constant change and
development in line with changing needs and circumstances.
Accounting Principles contribution to the development of accounting theory
The importance is that financial accounting depends on many of the principles and
concepts that have been established and evolved over the historical development of accounting,
such as pre-theory (1400s – 1800 ), pragmatic accounting (1800 - 1955), normative accounting
(1956 – 1970) and positive accounting (1950 to the present day) and often called the general
accepted accounting principles or GAAP.
It clarifies the method or procedures in which the financial statement items are processed
in a manner that harmonizes the records and listings of the entities in which such items
appear.The most important of these accounting principles are the following:
1. The Principle ofHistorical Cost:
This principle means that the financial transaction is established on the basis of the
amount of actual money (i.e. cost) used in the exchange for that transaction (the amount at which
the commodity was purchased(.
After proving such treatment, the cost thereof shall be recorded in the accounting books
and shall remain unchanged regardless of the change in value except for the use.For example,
buying a piece of land is recorded at the value that was bought and remains in the records of this
value, regardless of changes that may occur to the value of the land later
There is no doubt that adherence to these principles is due to the ease of verification of
these values and based on the basis of objectivity.There is a general agreement between the users
and preparers of the financial statements on the importance and necessity of using the historical
cost principle in recording financial transactions in the books and thus the use of historical values
as a basis for measuring the elements of the financial statements.
2. The Principle of Matching:
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The principle is that at the end of each accounting period (usually one year), the income of the
period must be met with the costs (expenses) required to achieve these revenues in order to arrive
at the net result of the activity for the period.
A) The accrual basis: It is required to record income and expenses for a specific period,
irrespective of the fact of collection or actual disbursement during that period. This basis is
consistent with accounting principles and is applied by most economic units.
B) Cash basis: It is required to recognize revenue when it is collected and expenses when
it is paid. This basis focuses on the actual collection or payment, regardless of whether the
income or expenses relate to the current period or a prior or subsequent period. This principle is
applied in small enterprises and in liberal professions such as the offices of accountants,
engineers and doctors.
3.The Principle of Revenue Recognition:
This principle means the time of recognition or recognition of revenue, i.e., the determination of
the point at which revenue is recognized in the entity's records. In accordance with this principle,
the point of recognition of revenue is determined upon completion of the swap, i.e. at the point of
sale. The prices are verifiable, however there are some exceptions to the use of the point of sale
as a point of recognition for revenue such as the point of production (in the case of agricultural
products and the extraction of petroleum and minerals), upon receipt of cash (in case of sale by
installments) and on the basis of percentage of completion or completion Contracting Status.
4.The Principle of Substance over form:
The substance over form is one of the main principles in accounting which helps
accountant greatly in deciding which the real owner of the asset is. In fact, it is the deciding
principle in various complex transactions where a lot of confusion may create significant
problems for the management and accountant.In order to present true and fair view of the
financial statements, accountants need to reflect transactions over the basis of economic
substance rather than over the legal form. Substance over Form is a major accounting principle
and its applicability is very wide in the industry.
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For example, The accounting for finance lease considers the substance over form
principle in to consideration. In finance lease, asset is owned by the bank (legal owner) but the
asset is used and remains under the control of the lessee for majority of the useful life of the
asset. Not just that, the present value of the lease payment is nearly equal to the fair value of the
asset. In this case, though asset is the property of bank, the lessee records this as assets under
finance lease in its financial statements.
5.The Principle of Gain and loss recognition:
This principles states that the gains recorded only when realized, butlosses when they
first become evident. Thus, the losses will be recognized at an earlier point than gains. This
principle is related to the conservatism principle. In others word, Gains may be recorded only
when realized butlosses should be recorded when they first become evident.
6.The Principle of Conservatism:
This principle means that in many situations of valuing assets and determining income
there are several values that represent alternatives in the field of evaluation.
In this case, the accountant chooses the alternative that does not increase the value of the
income and therefore does not increase the values of the asset elements in the statement of
financial position.This concept is an application of prudential accounting, which mean:Take care
to take the expected losses into account before they occur and be careful not to take the expected
profits into account when they actually do.
7. The Principle of Materiality:
This principle means that the interest in providing accuracy in the processing and analysis
of accounting information depends on the relative importance of the statement of income and the
statement of financial position.
While theoretically all data should be processed in the same way no matter how large or
small it is, in practice, the correct methods of processing data are often overlooked when they are
associated with relatively small values.
For example, the value of the purchased car, which is estimated to be used for 3 years, for
example, can be distributed over periods of use. While the cost of office equipment and supplies
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that are estimated to be used during the same period is not distributed because the cost of such
distribution does not match the returns that can be obtained from the most accurate processing.
8. The Principle of Objectivity:
The objectivity principle states that financial and accounting information needs to be
independent and free from bias. This means that financial reporting like a company’s financial
statements need to be based on evidence and not opinions. basically, in some areas professional
accountants need to express their opinions, but the objectivity principles says that opinions can’t
be the only bases for an accounting treatment.
9.The Principle of Full Disclosure:
The last principle is disclosure. It means that when preparing the financial statements, there must
be a complete public disclosure so that no information or data that may harm the beneficiaries or
the users of these data or lists may be hidden or may contribute to a specific decision.
The accountant must adhere to the neutrality when preparing these lists by fully
disclosing all information regardless of the extent of their impact on these lists.
In other words, this principle requires that the financial statements disclose all
information related to economic activity of the economic unit and are appropriate for decision
making. It also emphasizes the possibility of comparing the accounting information related to the
economic unit with other periods or similar to other economic units. So this requires consistency
in following the same policies, rules and methods.
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The effects of the term in the Conceptual Framework of Accounting
Since the conceptual framework is about to provide useful information for the user of
financial statement and the exciting of accounting principles, it was necessary to guide the
establishing of financial statements, so that justified why the accounting principle board (APB)
was founded.
The accounting principles has contributed in conceptual framework in making financial
statement and annual report, to make them appear conforming to these principles, thus to be
useful for the users.The following, are the main accounting principles that affect the conceptual
framework:
Historical Cost Principle:
Based on this principle the assists recorded in the balance sheet are record in purchases or
acquisition price and never adjust for change in the market or economy and change due
inflation.So, it reflected reliability and usefulness to the users of financial statements in how
much the Entity spend to get the assists.
Matching Principle:
This principle required the company to recorded its F.S, the expanses in the same period
as the related revenue so investors and creditors are know the revenue and the expanses that
incurred to get that revenue in the period.
So without this principle the company could record expanses in period that is not same of
revenue to its advantage thus, it could fool the investor or creditors.
Revenue Recognition Principle:
As it is known under this principle the revenue is recognized in the same time of doing
the services or providing the product, not in the time of receiving cash, so with this principle the
financial statements and the annual report will show the revenue that the company earn in that
period regardless receiving money or not thus, the user can tell what revenues that the company
get in a period.
Conservatism Principle:
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This principle is solving the cases when an accountant faces transactions that have two
alternatives. Based on this principle the accountants have to choose the alternative with less net
income or less assets amount.The conservatism principle leads the accountants to assume to
losses not gain.
Materiality Principle:
Based on this principle the accountant can decided whether an amount of any item is has
significant effect on users decisions or not. So with this principal the accountant can violate
another accounting principle if the amount is not insignificant. For example if company which
has a millions of profit yearly pay 200 $ equipment, the accountant can violate the matching
principle so instead of expensed it for 5 years each year 40$ they expanse it in the year of
purchase. The user will not give any attention to this equipment because it no material and will
focus items that could affect their decisions
Full Disclosure Principle
Sometimes the financial statements dose not included all the detailsthat the users seek for.
Full disclosure principle require from makers of financial statements to disclose these details in
F.S or in the footnote which often attached with the F.S.
Under this principle the users will be sure to get all information and details that they need
to make right decisions.
Principle of gain and loss recognition
This principle is relative to convictism principle. Under this principle the F.S will be
more reliable and credible through recorded the gain when it realized and recorded the losses
when they first become evident, recognize losses at an earlier point than gains.
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The issues and controversies of the accounting principles in accounting practice
In fact, the professional world of accounting is managed by general rules and concepts
that referred to as basic accounting principles and guidelines. Together, they shape the
groundwork for the more detailed, complicated and legalistic rules of accounting. Actually, there
are many issues and controversies of accounting principles in practice. Here are illustration of
some of these issues associated with practicing the accounting principles and how they affect the
related users.
Matching principle issues:
Firstly, matching principle stated that expenses shouldn't be recorded when they are paid.
Expenses should be recorded as the corresponding revenues are recorded. This matches the
revenues and expenses in a period. To explain the issues that may occurs by using this principle,
assume that a company that accept deposits for work to be done in the future are often record
those deposits as revenue in the period in which they are collected instead of deferring them to
that period in which they are earned.
As a result, this will create two problems: an overstatement of revenue in the collection
period as well as understatement of revenue in the period in which the work is performed. Since
the goal of accrual accounting is to provide meaningful financial information, the Matching
Principle ensures that results are measured in a consistent fashion over a long period of. Without
that, it would be difficult for management and the investing public to depend on published
financial information.
Full disclosure principle issues:
The second issue that can be led by the wrong practicing of the accounting principles is
related with the full disclosure. As it highly important to include all information in an entity's
financial statements that would affect a user's understanding of those statements. So, the main
problems in this area are: Not enough relevant information is being provided in all situations –
this can lead to inappropriate investing or lending decisions, Irrelevant information is being
disclosed which can uncertain relevant information, reduce understandability and add
unnecessary costs to the preparation of financial statements. In addition, relevant information
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that is provided is not always effectively communicated which can reduce understandability of
financial statements.
The cost principle issues:
The third accounting principle which has many issues in practice is the cost principle that
organizations used to record an asset, liability, or equity investment at its original acquisition
cost. The apparent problem with the cost principle is that the historical cost of an asset, liability,
or equity investment is simply its value on the acquisition date; it may have changed
significantly since that time. To explain the issue more, if a company were to sell its assets, the
sale price might bear little relationship to the amounts recorded on its balance sheet. Thus, the
cost principle yields results that may no longer be relevant, and so of all the accounting
principles, it has been the one most seriously in question. This is a particular issue for the users
of a company's balance sheet, where many items are recorded under the cost principle criteria; as
a result, the information in this report may not accurately reflect the actual financial position of a
business.
Moreover, the cost principle is less viable to long-term assets and liabilities. Though
depreciation, amortization, and impairment charges are used to bring these items into
approximate alliance with their fair values over time, the cost principle leaves little area to
revalue these items upward. So, if a balance sheet is heavily weighted towards long-term assets,
as is the case in a capital-intensive industry, there is a greater risk that the balance sheet will not
accurately reflect the actual values of the assets recorded.
The consistency principle issues:
As this principle recommend continuing using the adopted method consistently in future
accounting periods. Some issues arise in certain situation. For instance, the consistency principle
is most likely ignored when the managers of a business are trying to report more revenue or
profits than would be allowed through a certain interpretation of the accounting standards. A
telling indicator of such a situation is when the company operational activity levels do not
change, but profits suddenly increase.
Furthermore, Auditors are especially concerned that their clients follow this principle, so
that the results reported from period to period are could be compared. This means that some
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audit activities will include discussions of consistency issues with the management team. If there
are clear and unwarranted violations of the principle, auditor may refuse to provide an opinion on
a client's financial statements.
Revenue Recognition issues:
Revenue, as it the top line on financial statements, and also the most important. But, it is
not always could be compared between companies, since the amount reported depends on when
the company recognizes the revenue as earned, not when it’s received. Here, some issues will
arise. For instance, long-term infrastructure projects can have fixed or variable costs or both,
multiple deadlines, and mixed cash receipts and expense payments. In addition, they can also
provide a mix of both goods and services. These factors make it difficult to estimate when
revenue should be recorded, and in what certain amounts.
Other example can be seen in technology firms that provide a combination of hardware,
software, servicing, consulting, support, upgrades and warranties where sometimes all in one.
These products and services can be interdependent which make it difficult to measure the
revenue that they earn every quarter over an extended period.
CONCLUSION
These principles are the building blocks that form the basis of more complex and
specialized principles called GAAP or generally accepted accounting principles such as the
International Financial Reporting Standards, US GAAP, etc. They deal with matters like
accounting for revenue, accounting for income taxes, accounting for business combinations.
Accounting principles are by no means detailed - consider them instead to be general guidelines.
Within these principles, only oneprinciplethatbeing seriously challenged which is the revenue
recognition. All of the others have stood the test of time, and will likely continue to be the
guiding principles upon which accounting activities will be based in the future.
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SCIENTIFIC SOURCES AND REFERENCES
- "Accounting Theory 5th", Dr. Ahmed Riahi-Belkaoui, publisher of the university of Illinoies at
Chicago Illinois, USA, 2012.
- "Fundamentals of Financial Accounting", d. Hassan Ahmed Ghalab, and others, publisher Ain
Shams Library, 2002 - 2003 AD.
- "Financial Accounting (1)", d. Dr. Kamal El-Din Mostafa El-Dahrawi, Abdul Wahab Nasr Ali,
publisher of the University Printing House, 2006.
- "Principles of Accounting for Scientific and Practical Assets - Part 1", by Dr.NaimDahmash,
Mohammed Abu Nassar, d. Mahmoud Khalayleh.
- "Accounting principles. a business perspective, financial accounting (Chapters 1-
8)"Hermanson, R. H., Edwards, J. D., & Maher, M. (2015). Los Gatos, CA, USA: Textbook
Equity Inc.
- Written by Obaidullah Jan, ACA, CFAhire me at. (2001). Substance Over Form. Retrieved
December 10, 2017, from https://accountingexplained.com/financial/principles/substance-over-
form
- (2016, April 3). Retrieved December 16, 2017, from https://www.cliffsnotes.com/study-
guides/accounting/accounting-principles-i/principles-of-accounting/generally-accepted-
accounting-principles
- Staff, I. (2015, May 28). Accounting Principles. Retrieved December 16, 2017, from
https://www.investopedia.com/terms/a/accounting-principles.asp
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