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Accounting Principles & Standards: Avoid Them At Your Peril
By John Day
Accounting principles are the basic assumptions, rules of operation, and essential characteristics that make up the framework for the construction of financial statements.

Long ago, I was perplexed to discover that there was no “set” of principles that was presented in one form such as you might find in the Bill of Rights. This is not to say that the principles are incomplete or vague, it only means that the definitions of principles can be presented in various formats, which may lead to confusion for some people, especially beginners.

Be that as it may, principles are absolutely necessary when preparing financial statements, just as the rules of a particular card game make the card game possible in the first place. principles are like the glue that holds the process together. For example, financial statements have an overall objective, which is to provide the user of the statements a useful tool for making business decisions.

In order to be useful, the information must have certain characteristics, such as being dependable and practical. To be dependable, the information must be unbiased, accurate, and verifiable. To be practical, information must be predictable, prepared in a timely fashion, and be able to provide meaningful feedback. Additional characteristics are that the information must be consistent, comparable, serve a utilitarian need (such as cost/benefit), and make a material difference.

Besides characteristics, certain operational rules are established as to when revenue and expenses are reported; how expenses are matched to revenue; what to do when a choice can be made that might overstate or understate figures; and, what information should be disclosed so that the reader will fully understand the circumstances under which the information is being presented.

There are also basic assumptions that the reader can count on, such as: the information is related to the business entity only and doesn’t have any unrelated information mixed in; the business is a going concern and won’t cease operations soon; the financial information presented is measured in specific time intervals such as a month, quarter or year; the financial information

is using a certain unit of measure such as dollars, not board feet, etc.; the information is presented at historical cost, i.e., when received, paid, or incurred; and, the method of being used is double-entry and not some other method.

These are principles as opposed to standards. An standard is an agreement as to how an issue will be treated. For instance, a standard might state what type of inventory system is appropriate to use for a certain type of business; how capital leases should be recorded; how many years intangible assets should be amortized; what methods of depreciation should be used, and so on. There are literally thousands of standards that have been issued over the years. These standards are constantly being revised or discarded as they become outdated.

If you want to play the “game of cards”, you must become familiar with the “rules of the game”, which are principles and standards. If you choose to not play by the rules, you do so at your own peril, as we have seen recently in the U.S. corporate scandals.

Article Source: http://www.ArticleJoe.com

John W. Day, MBA is the author of two courses in basics: Real Life for Non-Accountants (20-hr online) and The HEART of (4-hr PDF). Visit his website at www.reallifeaccounting.com to download for FREE his 3 e-books pertaining to small business and his monthly newsletter on issues.


 
 
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