Accounting concepts and principles 101: All you need to become an accounting master

By Nguyen Oanh

Published: 9 February 2022

You are confused and don’t know what accounting concepts and principles are? Don’t worry, here is the guide to help you understand it!

Accounting is based on accounting concepts and principles, which must be respected. These accounting concepts and principles are important because they make it possible to meet an essential objective of accounting: the transmission of reliable economic and financial information for those who read the accounts and other financial documents.

Discover what the basic accounting concepts and principles are, and why they are important in this article.

Let’s get into it now!

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What are the basic accounting concepts and principles?

Accounting principles help ensure the consistency and reliability of a business's accounting information. The chartered accountant must respect these principles to establish the annual accounts of a business. These annual accounts must be regular, honest, and be faithful to the assets, the financial situation, and the results of the business.

👉 It should be noted that the same accounting principles are not followed in all countries. In some fields, some are included and in others, they are omitted. For example, in the United States, they are known as GAAP, which stands for “Generally Accepted Accounting Principles”. And in the UK, the GAAP becomes UK GAAP to adapt to the UK regulations.

With economic globalization, the unification of accounting standards is essential. However, each country has different tax regulations, a tax system with particular characteristics, and it is complex to adapt the principles to all countries. Thus, without prejudice to the foregoing, more and more work is being done on international principles following the International Financial Reporting Standards (IFRS).

In terms of accounting concepts, keeping rigorous and perfect accounts first requires an introduction to the jargon used. There are the eight most recurrent financial terms or concepts in the accounting field that you need to know, especially for entrepreneurs who need to have an overview of the assets of their companies. Just keep reading because we will detail them down below!

Why are the basic accounting concepts and principles important?

The accounting principles make it possible to make the transparency of financial information mandatory, but this requires a format for the balance statements and annual accounts of companies. In other words, these principles create financial communication standards for companies. A multinational will deposit its accounts as an artisan. Accounting principles are very stable over time. They are not changed often.

The accounting concepts are prescriptive in nature and serve as instructions to determine how and for what amount financial transactions should be recorded in its accounts. These concepts also contain more general requirements on the structure and presentation of financial statements.

The key accounting principles

Every business is legally bound to respect these rules when recording its transaction, drawing up its accounting statement, and its annual financial accounts.

The going concern principle

The principle of continuity of operation is based on the fact that when a business draws up its balance statement, we assume that it will continue its activity, its transactions beyond the closing date of the financial period. In the going concern principle, an entity has an aim to proceed with its activity for financial periods to come.

Using this accounting principle, it is possible to record accounting depreciation over several financial periods (investment in equipment for example), to distribute costs over a successive accounting period.

If the principle is not respected and if the business ceases its financial activity after the end of its financial period, all the revenues or cash will then have to be depreciated according to the market. In this specific case, the book value of the assets is much lower.

The principle of independence of exercises

A financial period is over a year. At the end of this same year, an annual financial account is established. This accounting principle requires an accounting act to be linked to the financial period in which it takes place.

For example, customer and supplier invoices must be attached to the fiscal period they concern, regardless of whether the time information corresponds to a service provision or a purchase that took place during the previous fiscal period. This accounting principle requires that the invoice be recognized only once.

The historical cost principle

This accounting principle requires that items recognized on their date of entry into the business are recorded as their acquisition expense. Goods acquired free of charge are recorded at an estimated value and products at their cost of production.

The updating of their value's transactions overtime is not taken into account (at the time of the balance statement, the value should not be reassessed even if it has increased). If, on the contrary, the value of the property has fallen, the business must record a provision to recognize the depreciation.

So, if the business bought equipment for £2000 in 2015, its value in 2018 will still be £2000.

The precautionary principle

This is the most important accounting principle. It is an accounting principle that encourages not to transfer uncertainties (probable or certain losses) to a future accounting period. Indeed, these uncertainties can have negative effects on the assessment of the financial result of the assets of a business. Care must be taken in accounting!

Any probable loss, even if it does not occur until the following financial period, must be taken into account. But it must be part of depreciation by amortization or a provision. Otherwise, a gain cannot be anticipated.

The principle of permanence of methods

Compliance with the principles of accounting registration for a business is important. A business is required to always have the same accounting methods throughout its financial period. It cannot change its accounting methods of impairment, for example, from one year to the next.

For example, if a business buys computers every financial period and has depreciated its first computers over 3 years, it will have to continue to depreciate the other computers over the same financial period.

But it is possible to modify this principle a little in the two situations below:

when the business changes method and chooses a preferential financial method;
when the business changes method due to an exceptional situation.

The principle of materiality

In this accounting principle, records that have only small importance can be set aside. But all those that turn out to be significant must be taken into consideration and recorded in the accounts if they are significant for decision-making, or for a fair representation of assets and activity. Transactions must be made public.

Accrual principle

The accrual accounting principle is a principle in which the cash flow and expenses generated by the activity of the organization are recorded during the financial period, during which the generating events of the assets and expenses were observed, the date of collection, or disbursement of funds not being taken into account.

The accrual method of accounting gives a more accurate picture of the business's financial situation than the cash method of accounting.

The principle of pre-eminence of reality over appearance

Compliance with this accounting principle encourages the recording and presentation of information that is understandable by the various readers of financial documents. The accounting principle must present the operations carried out by the business in accordance with their nature and their financial and economic reality. The information must be reliable and complete.

Here, the substance is superior to form. A business should not theoretically present leasing as it would present a loan. Legally, these are very different contracts.

Principle of double-entry bookkeeping

In accounting, the double-entry principle is one of the bases whereby each business transaction is recorded twice in different accounts, once in debit and once in credit. Transactions are recorded in two ways: at the balance statement level and at the income statement level.

The different accounting concepts

You should at least be familiar with these few technical expressions to better manage a structure that needs to manage finances.

Assets and liabilities on the balance sheet

The first accounting concept is the balance statement. This financial record is a summary statement that consists of assets and liabilities representing the assets and resources information of a business.

Assets record cash, revenue, bank or postal assets, fixed assets such as equipment and vehicles, real estate, and equity investments, among others. Therefore, the assets represent the allocation of the capital available by the business.

The opposite of assets, liabilities record the origin of resources either in the form of expenses, debts, mortgages, or others. At the accounting level, we find what is designated by the equity, which corresponds to the difference between the assets and the debts, and this information is recorded at the level of the liabilities of this financial statement.

Expenses and income, the components of the income statement

The second accounting concept is the income statement. When we talk about charges, these are the revenues and expenses representing the consumption of goods and services necessary for the production and operation of the structure.

It includes the purchase of goods for resale, wears and tears of equipment represented by depreciation allowances, payment of expenses and salaries, rent, tax payments information, etc. And in return, we find the revenues or income that constitute the increase in value, realized by the business mainly through sales and other revenues sources.

In this type of account, we find receipts, bank interest received, provisions, etc. It should be noted that assets and expenses are taken into account over a limited period, generally corresponding to the accounting period.

Accounts receivable and creditors

Another accounting concept is the accounts receivable that records the assets' information held with customers following the sale of goods or services and which remain to be paid. In other words, these are the sums of money that customers owe the business.

As for accounts payable, they represent purchases that the business only pays in the long term. They, therefore, constitute what the business owes to its suppliers. Good accounts receivable management will ensure the financial health of the business.

Income statement or profit and loss account

It is a financial document that records the expenses and the product's information in order to come out with a positive result, either a profit or a negative result, therefore a loss. The result obtained is subsequently reported on the balance statement and must correspond to the difference between the assets and the expenses.

In this accounting concept, credit represents the right side of an account, while debit represents the left side. And in compliance with the principle of the double part, any transaction made at the debit level finds its counterpart in the credit of another account. The asset and expense accounts increase on the debit side and decrease on the credit side, while the liability and income accounts change inversely.

💡 If you want to know more, check out this article about accounting terms, principles, and concepts.

Business entity concept

An entity is an object or thing made up of many characteristics or properties. In other words, it is the assembly of a set of records forming a specific identity or a proper existence. As for a commercial entity, this principle represents the meeting or association of several natural or legal persons providing know-how, capital, or equipment with the aim of gaining market share and making profits.

Accounting year concept

This accounting concept designates a single period during which the company quickly recognizes all the transactions carried out within the structure. At the end of the accounting period, the latter is required to produce various documents enabling its financial situation to be assessed. Some of these documents are designated to the tax authorities and will be used to justify the declared tax. This is why some also use the term "fiscal period".