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The Basic Principles of Accounting

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The set of rules that governs the field of accounting are known as accounting principles. Accounting principles are conventions that provide a framework for accounting, book keeping, and financial reporting. These principles are essential for businesses preparing their financial statements. For reporting purposes, both internal and external, accounting principles ensure that the financial information should not be misleading for its users.

During the Great Depression of 1929, US Government passed a law for the creation of convention, principles, and standards for accounting practices. These principles are known as Generally Accepted Accounting Principles or GAAP. GAAP helped in standardizing the practices used in the accounting industry for preparing financial statements. With the help of GAAP debtors, creditors and investors can analyze the financial health of the company and also compare its performance with other companies. All the companies are expected to follow these generally accepted accounting principles when they are preparing their financial statements. The topics that GAAP covers are assets, liabilities, revenue, expenses, equity, preparation of financial statements, and all the other industry-specific accounting practices pertaining to aviation, banking, etc.

There are three principles of accounting. These are:

  1. The Business Entity Concept – In accountancy, a clear distinction has been made between the business and its proprietor. Business Entity Concept means that the business should be treated as a separate entity from its owner. A business is a separate entity in the eyes of laws. In legal terms, it can be said that a business can exist even after the existence of its proprietors. Even in the books of accounts of business entity, each transaction is recorded from the perspective of the business and not from point of view of the proprietor.
  2. Going Concern Concept – Going concern concept explains that the business until and unless entered into liquidation, is to be considered having a perpetual or an indefinite life. American Institute of Certified Public Accountants defines it as “’going concern’ concept assumes that the business will remain in existence long enough for all the assets of the business to be fully utilized. Utilized assets mean obtaining the complete benefit from their earning potential”. Any business is said to going concern when there is neither an intention nor the necessity to wind up its operations in foreseeable future.
  3. Full Disclosure Concept – Full disclosure concept requires that companies should reveal every aspect of its accounting in their financial statements. According to this concept financial statements should provide fair and full information about they purport to represent.

To meet the requirement of Full Disclosure concept, financial statements are supported by the footnotes. For example, market value of investments, methods used for valuation of investments, inventories and methods used for charging depreciation on fixed assets, etc. are shown in the Balance Sheet as footnotes. The purpose of full disclosure concept is to provide all material and relevant facts pertaining to the financial health and results to its users.

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