Accounting Principles - Meaning, Overview, List of Top 6 Accounting Principles

Summary

This video from WallStreetMojo provides a clear and comprehensive guide to essential accounting principles. It explains what accounting principles are, why they matter for investors and business owners, and introduces the two main frameworks: GAAP (used in the U.S.) and IFRS (used globally). The tutorial covers six key principles—Accrual, Consistency, Conservatism, Going Concern, Matching, and Full Disclosure—explaining each with practical examples. Viewers learn how these principles ensure transparency, consistency, and reliability in financial reporting, helping investors make informed decisions and businesses comply with regulations for accurate financial statements.

Takeaways

• 😀 Accounting principles are a set of rules and guidelines that companies follow to report financial data accurately.
• 😀 Investors use accounting principles to evaluate a company's financial health, while business owners follow them for proper financial reporting.
• 😀 GAAP (Generally Accepted Accounting Principles) is the primary accounting framework used in the United States for public companies.
• 😀 Compliance with GAAP is essential for companies to remain listed on major US stock exchanges.
• 😀 IFRS (International Financial Reporting Standards) is a global accounting standard used outside the US for consistent financial reporting across countries.
• 😀 The accrual principle requires companies to record transactions in the period they occur, not when cash is received.
• 😀 The consistency principle mandates that companies consistently apply the same accounting methods over time for comparability.
• 😀 The conservatism principle advises reporting potential losses early, which results in lower assets and profits to avoid overstating financials.
• 😀 The going concern principle assumes that a company will continue operating in the foreseeable future, affecting decisions like depreciation deferral.
• 😀 The matching principle ensures that revenue and related expenses are recorded in the same period for accurate financial results.
• 😀 The full disclosure principle requires companies to reveal all relevant financial information to allow informed decision-making by investors.
• 😀 Understanding both GAAP and IFRS helps investors and auditors compare companies globally and maintain transparent financial reporting.

Q & A

What are accounting principles and why are they important?

Accounting principles are rules and guidelines that companies follow to report financial data accurately. They ensure transparency, consistency, and comparability in financial statements, helping both investors and company owners make informed decisions.

How does the perspective of an investor differ from that of a company owner regarding accounting principles?

Investors use accounting principles to evaluate whether a company follows proper financial reporting before investing. Company owners, on the other hand, must apply these principles to prepare and report their financial statements according to regulatory requirements.

What is GAAP and why is it important for U.S. public companies?

GAAP (Generally Accepted Accounting Principles) is a set of rules and guidelines for financial reporting in the United States. U.S. public companies must comply with GAAP to ensure transparent, consistent, and reliable financial statements, which is required to remain listed on major stock exchanges.

What is IFRS and how does it differ from GAAP?

IFRS (International Financial Reporting Standards) is a set of global accounting guidelines used outside the U.S. Unlike GAAP, which can vary by region and industry, IFRS provides consistent rules worldwide, making it easier for investors to compare financial statements across countries.

What is the accrual principle in accounting?

The accrual principle requires companies to record transactions in the period they occur, regardless of when cash is received. For example, sales made on credit are recorded when the sale happens, not when payment is collected.

What does the consistency principle ensure?

The consistency principle ensures that a company consistently follows the same accounting methods over time. This prevents erratic reporting and allows investors to track the company’s long-term financial performance accurately.

Can you explain the conservatism principle with an example?

The conservatism principle states that when faced with multiple reporting options, accountants should report the lower asset value or higher liability. For example, if machinery purchased for $60,000 decreases in market value to $50,000, the loss should be recorded immediately to avoid overstating profits.

What is the going concern principle?

The going concern principle assumes that a company will continue operating for the foreseeable future. This allows it to defer certain expenses, such as depreciation, to future periods without affecting the validity of financial statements.

How does the matching principle relate to the accrual principle?

The matching principle requires that revenues and all related costs and expenses be recorded in the same period. It is based on the accrual principle and ensures that financial performance is accurately reflected in each accounting period.

Why is the full disclosure principle important for investors?

The full disclosure principle requires companies to provide all relevant financial information, ensuring that investors can make informed decisions. Without it, financial statements could be misleading or incomplete.

What is the overall purpose of following accounting principles?

The purpose of accounting principles is to create transparent, consistent, and comparable financial reports. This benefits investors, regulators, and company management by providing reliable information for decision-making and maintaining trust in financial reporting.