Accounting Rules
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Why Have Rules ?
All games such as football, baseball, basketball, and others have rules. Why ? So that everyone plays the game the same way. Playing the Accounting "Game" is no different.
What if owners and managers could prepare their business's financial statements the way they felt like ? If a business was wanting a loan or credit, they would have a tendency to overstate the value of their assets and the value of their business. If it came to taxes (we don’t like to have to pay them), let’s expense and write off everything. As for measuring performance (profitability) and comparing businesses in the same industry, you’d have no idea as to who was actually doing well and who wasn’t. You couldn’t even compare your own business from year to year. As to coming up with a reasonable value for what a business was worth, your guess would be as good as mine.
So, to put all businesses on the same playing field, the accounting profession has established some rules and guidelines. Two notable accounting rule making and standards setting organizations are the United States’ Financial Accounting Standards Board and the International Accounting Standards Board . The current accounting rules and standards are continually reviewed, studied, changed, and added to in order to make financial presentations more consistent, comparable, meaningful, and informative.
Let's discuss some of the major rules.
Double Entry System
The double entry system is the standard system used by businesses and other organizations to record financial transactions. Since all business transactions consist of an exchange of one thing for another, double entry bookkeeping using debits and credits , is used to show this two-fold effect. Debits and credits are the device that provide the ability to record the entries twice.
The total of the debit values recorded must equal the total of the credit values recorded. This system, when used along with the accrual method of accounting, is a complete accounting system and focuses on the income statement and balance sheet. This system has worldwide support as the system to use by businesses for recording their financial transactions.
Accrual Method
The accrual method or basis of accounting records income in the period earned and records expenses and capital expenditures such as buildings, land, equipment, and vehicles in the period incurred. The purpose of the accrual method of accounting is to properly match income and expenses in the correct period.
In order to accomplish this, the accrual method of accounting records revenue as earned when the product and/or service is shipped or rendered and invoiced (billed) to customers. Likewise, expenses and capital expenditures are recorded as incurred when the product and or service is shipped or rendered and invoiced (billed) by the supplier. This is the accounting method that is required to be used in order to conform to generally accepted accounting principles in preparing financial statements for external users.
Revenue Realization Concept
The revenue recognition principle requires companies to record revenue when it is realized or realizable and actually earned. In other words, at the time the goods are actually sold or the services are rendered.
Matching Concept
The Matching Principle goes hand in hand with the Revenue Realization Principle. The matching principle is recording the revenues earned during a period using the revenue realization principle and matching (offsetting) the revenues with the expenses incurred in generating this revenue.
Cost Concept
This principle requires that most assets are recorded at their original acquisition cost and except for a relatively few exceptions no adjustment is made for increases in market value. In other words, the value of an asset is never “written up” even though the asset may actually be worth more than its cost. On the other hand, the cost is sometimes “written down” for example marketable securities and inventory.
Consistency Concept
The same accounting methods should be applied from period to period and all changes to more acceptable methods should be well explained and justified. Deviations in measured outcomes from period to period should be the result of deviations in performance not changes in methods.
Comparable
Information must be measured and reported in a similar manner by all types of businesses. This allows comparison of the financial statements of different entities (businesses) or comparisons for the same entity (business) over different periods.
Accounting Rules