Essential Accounting Principles Every Financial Manager Should Know

Every financial manager should be well-versed in accounting principles to make good decisions and maintain the financial health of the company.
Accounting principles are rules and guidelines that companies and others must follow when reporting financial data. The goal of accounting principles is to ensure that a company’s financial statements are complete and easily understandable. It also helps to prevent accounting fraud by increasing transparency.

Here are some major accounting principles to follow

Accrual principle: It is one of the best accounting principles because it mandates the recording of transactions in the time period in which they occur, regardless of when cash is received. It helps maintain accurate information on the financial status of a company.

Consistency principle

The main goal of this accounting principle is to make financial statements comparable across all companies and industries. According to this principle, when a company chooses one method for reporting and documentation, they must use the same method in the future to avoid errors between reports. There are two major issues with this principle – first, it may not work properly if many people are recording and combining data, so the company needs to set a method internally. Second, switching between financial reporting methods can be problematic, but companies must do so to use data to their advantage.

Conservatism principle

This principle provides a perspective on unexpected situations. It suggests that expenses and liabilities should be recognized early, even if there is uncertainty about the outcome. It also recommends recognizing revenues and assets when there is assurance of their receipt. This principle can also be applied to recognizing estimates and is the foundation of lower cost, recording inventory at the lower end of its current market value or acquisition cost.

Cost principle

Also known as Historical Cost, this principle dictates that when a company acquires an asset, its value is recorded in the company’s financial reports. Companies keep a record of their tangible assets without reflecting the market value. This principle helps companies assess the actual cost of using financial services to calculate the cost principles of the company’s assets.
Going concern concept: This is one of the most important accounting principles, assuming that a company will remain profitable in the future and not be liquidated. It also means that major fixed assets of the company are not listed as items for sale.

Materiality principle

According to this principle, information that would influence the decision of the person should be included in financial reports. This principle also allows managers to focus on financial data without any errors.
Full disclosure principle: According to this principle, all information should be disclosed in financial statements to avoid misleading understanding towards stakeholders. It’s good for the company to manage data in a good manner. As per the disclosure principle, it also includes those items that cannot be quantified. Companies are also liable to report existing accounting policies and any changes in them as well.

Time period principle

Here, two main regulatory bodies develop the principles based on accounting concepts. IFRS and GAAP develop these principles. US-based companies follow GAAP principles whereas, outside the US, almost all countries follow IFRS principles. GAAP is static in comparison with IFRS. IFRS also builds principles to address the financial condition in the world.

Tax compliance principle

This principle helps in understanding and adhering to the tax obligations arising from financial transactions and operations. A knowledge of tax implications can influence accounting decisions like asset valuation and revenue recognition, ensuring that the company is familiar with tax law while optimizing its tax position.

Matching principle

This principle states that the company has to record the expense in the same period. This principle was part of the accrual accounting method that provides an accurate representation of operations on the financial statement. This principle is also useful for investors to match revenue and expenses to get a better sense of the company’s finances. Along with the income statement, there is also a need to assess the cash flow statement as well.

Full disclosure principle

This principle focuses on providing all relevant and good information in financial statements. The company should understand the importance of transparent reporting to ensure users have a good understanding of the company’s final position and performance.

Realization principle

This principle states that a company should record revenue from any business transaction only when it’s realized. According to the principle, a company earns revenue only when the organization gives its goods and services to customers through cash or some asset in exchange. In simple language, revenue is realized when a business earns it but not when it collects revenue.