Summary
Accounting principles are the fundamental rules and guidelines that businesses follow when preparing their financial accounts, ensuring reliability and comparability.
- Matching Principle — Expenses should be matched with the revenue they help generate in the same accounting period. Example: If a business pays $12,000 rent for the year in January, the full amount is charged as an expense for that year.
- Business Entity Principle — The business is treated as separate from its owner, keeping personal transactions separate from business accounts. Example: If the owner withdraws $500 for personal expenses, it is recorded as drawings, not a business expense.
- Consistency Principle — Businesses must use the same accounting methods from one period to the next for comparability. Example: Using the straight-line depreciation method consistently each year.
- Duality Principle — Every transaction has two effects and must be recorded in at least two accounts. Example: Buying $1,000 of goods for cash increases inventory and decreases cash.
- Going Concern Principle — Assumes a business will continue to operate, affecting asset valuation. Example: Machinery valued at cost less depreciation, not resale value.
- Historic Cost Principle — Assets are recorded at their original purchase cost. Example: Land purchased for $200,000 remains recorded at that amount despite market changes.
- Materiality Principle — Significant items are recorded in detail; insignificant items are treated simply. Example: A delivery van is recorded as a non-current asset, while a stapler is an immediate expense.
- Money Measurement Principle — Only transactions measurable in money are recorded. Example: Purchase of equipment for $10,000 is recorded, but employee skills are not.
- Prudence Principle — Anticipate losses, not profits, to avoid overstating financial position. Example: Creating a provision for doubtful debts.
- Realisation Principle — Revenue is recognized when earned, not when cash is received. Example: Revenue from goods sold on credit is recorded when delivered.
Exam Tips
Key Definitions to Remember
- Matching Principle: Expenses matched with revenue in the same period.
- Business Entity Principle: Business is separate from the owner.
- Consistency Principle: Use the same accounting methods each year.
- Duality Principle: Every transaction affects at least two accounts.
- Going Concern Principle: Business will continue operating.
- Historic Cost Principle: Assets recorded at original cost.
- Materiality Principle: Significant items recorded in detail.
- Money Measurement Principle: Only monetary transactions recorded.
- Prudence Principle: Anticipate losses, not profits.
- Realisation Principle: Revenue recognized when earned.
Common Confusions
- Confusing the Matching Principle with the Realisation Principle.
- Misunderstanding the Business Entity Principle as including personal expenses.
Typical Exam Questions
- What value should equipment be recorded at if purchased for 18,000? Answer: $15,000, following the Historic Cost Principle.
- How should a $500 personal withdrawal by the owner be recorded? Answer: As drawings, applying the Business Entity Principle.
- How is a $3,600 insurance payment for the year treated? Answer: As an expense for the year, following the Matching Principle.
- What should be done if a customer owes $800 and is unlikely to pay? Answer: Create a provision for doubtful debts, following the Prudence Principle.
What Examiners Usually Test
- Understanding of key principles and their applications.
- Ability to identify which principle applies to specific scenarios.
- Correct recording of transactions according to principles.