Fundamental Accounting Principles and Standards
Fundamental Accounting Principles
Accounting, as a science, interprets the economic facts of a business. It organizes these facts into accounts for control and presentation. Accounting rests on principles that form its foundation. These principles have been defined based on the experience of the accounting profession and the constant quest for improvement in interpreting economic events in the business world.
1. Equity
Equity between competing interests must be a constant concern in accounting. Users of accounting data may have conflicting interests. Therefore, financial statements should be prepared to reflect fairly the different interests at stake in a given entity. This principle is fundamental and underlies all others.
2. Accounting Entity
Financial statements relate to specific economic entities, which are distinct from their owner(s).
3. Business Continuity
It is assumed that there is no time limit on the operational continuity of the economic entity. Therefore, the figures in the financial statements do not reflect their estimated realizable value. If there is reasonable evidence to the contrary, this should be stated along with its effect on the financial situation.
4. Economic Assets
Financial statements relate to events, resources, and financial obligations that can be valued in monetary terms.
5. Currency
Accounting is measured in monetary terms, which allows heterogeneous components to be reduced to a common denominator.
6. Period of Time
Financial information summarizes data concerning certain time periods. These periods are determined by the normal cycle of operations of the entity or by other legal requirements.
7. Accrual
The determination of operating results and financial position should take into account all resources and obligations of the period, whether or not they have been collected or paid. This ensures that costs and expenses are properly related to the respective revenue they generate.
8. Realization
Economic results should only be counted when they are realized. This occurs when the operation is improved from the point of view of the law or applicable trade practices, and all inherent risks have been correctly assessed. Generally, the term “realized” is part of the concept of accrual.
9. Historical Cost
The recording of transactions is based on historical costs (production, purchase, or exchange). A different criterion (e.g., realizable value) may be applied if justified by other principles. Corrections for currency fluctuations do not alter this principle; they simply adjust the numerical expression of the respective costs.
10. Objectivity
Changes in assets, liabilities, and equity should be recorded as soon as it is possible to objectively measure these changes.
11. Prudential Criterion
The measurement of resources and accounting obligations requires estimates to distribute costs, expenses, and revenues over relatively short periods and between different activities. The preparation of financial statements, therefore, requires a healthy approach in selecting the basis for making a wise decision. This involves choosing the most conservative option when faced with two or more alternatives. This approach should not be affected by the presumption that financial statements could be prepared based on a series of inflexible rules. In any case, the criteria adopted must be sufficiently verifiable to enable an understanding of the reasoning that was applied.
12. Materiality or Relative Importance
In weighing the proper application of principles and rules, common sense must be applied. Situations may arise that do not fit with the principles and rules but present no problems because they do not distort the financial statements taken as a whole. There is no fixed boundary line to set the limits of what is and is not significant. The best approach should be applied in each case according to the circumstances, taking into account factors such as the relative effect on assets, liabilities, equity, or the results of operations for the accounting year.
13. Consistency
Quantification procedures used must be consistently applied from one period to another. If there are reasonable grounds to change procedures, this fact and its effect should be disclosed.
14. Substance Over Form
Accounting emphasizes the economic substance of events, even though the law may require different treatment.
15. Economic Duality
The accounting structure is based on this premise (duality) and consists of: a) resources available for achieving the targets set as a goal, and b) the sources of these resources, which also demonstrate the various liabilities incurred.
16. Basic Relationship of Financial Statements
The results of the accounting process are comprehensively informed by a statement of financial position and a statement of results, both of which are necessarily complementary.
17. General Objectives of Financial Information
Financial information is intended primarily to serve the common needs of all users. It is also assumed that users are familiar with business practices, the accounting language, and the nature of the information presented.
18. Disclosure
Financial statements must contain all basic information and additional discrimination needed for proper interpretation of the financial and economic performance of the entity to which they relate.
Accounting Standards
Accounting standards represent the consensus, variable over time, as to which economic resources and obligations should be recorded as assets and liabilities, what changes should be reflected in them, how the assets and liabilities and changes in these should be measured, what information should be disclosed and in what form, and what kind of financial reports should be prepared. These rules can be classified into two groups:
- General
- Specific