In the contemporary business world, financial accounting plays a vital role in the success and continuity of companies. Because it is science that reflects the health and performance of companies through analyzing and documenting financial data. So, have you ever wondered about financial accounting principles? In this article, we will explore the world of accounting and learn about the basic principles that accountants have to maintain the transparency of financial operations and provide accurate and valuable information to investors, shareholders, and third parties. We will also review basic concepts such as the principle of revenues and costs, the principle of financial health, the principle of disclosure, and much more. Other principles that form the basis of the work of financial accountants are: So, if you want to explore this world and understand its foundations, don’t miss reading this exciting and useful article.
Overview of financial accounting principles
Introduction to accounting principles
Accounting principles provide the basic framework for accounting and are a global standard for recording financial operations and preparing financial reports. It is worth noting that accountants work to apply these principles toto ensure the reliability and accuracy of financial information and reports.. ThisThis contributes significantly to achieving transparency and enabling comparison between companies by unifying accounting standards and improving financial transparency, in addition to enabling investors and shareholders to make informed financial decisions.
What are the four accounting principles?
There are a number of accounting principles that we will discuss in detail here in this paragraph, which are as follows:
The principle of continuity
The going concern principle is one of the most important accounting principles, and according to this principle, it is assumed that the company will continue to operate for the foreseeable future.
Based on this assumption, accountants must record assets, liabilities, expenses, and revenues on this continuum. This means that accounting considers the company as an entity independent of its owners, and its activities are independent.
Balance principle
The principle of balance requires that the value of assets be compatible with the value of financial resources. In other words, the company must have financial resources equivalent to the value of the assets it owns. It is worth noting that this principle helps ensure a financial balance for the company and contributes to providing an accurate picture of its financial situation.
Sustainability principle
The principle of sustainability, which is one of the important accounting principles, requires that financial information be documented and recorded accurately and reliably. Accountants must maintain financial records and documents for a specific period of time in accordance with applicable accounting requirements. It is worth noting that this principle aims to ensure credibility and transparency in financial reports and helps in providing evidence to support the financial information provided.
Revenue principle
The revenue principle assumes that revenues are recorded when they occur or when the sale is actually completed and estimable, regardless of cash or other means.
This principle aims to ensure that revenue is recorded in a fair and reliable manner and to avoid inflating or delaying revenue recognition.
The importance of financial accounting principles
Financial accounting principles are an important basis for maintaining transparency and enabling comparison between companies, in addition to understanding the financial performance of each. It is worth noting that they contribute to establishing uniform and reliable accounting standards. This facilitates the analysis and evaluation of the financial performance of a variety of companies, in addition to the following:
Unification of accounting standards
One of the ways in which accounting principles contribute to achieving transparency and comparison between companies is by unifying accounting standards. Through these principles, it provides uniform and globally accepted accounting standards, which facilitates the process of comparing companies and understanding the financial statements provided.
Achieving financial transparency
Accounting principles contribute to achieving financial transparency by enhancing the principles of full disclosure and financial health. When these principles are applied, it provides accurate and transparent information about companies’ financial performance, which makes it easier to understand and better evaluate.
Evaluating and comparing financial performance
Thanks to these principles, investors and shareholders are able to evaluate and compare the financial performance of different companies, thus making informed financial decisions. These individuals benefit from the accounting information provided by these principles. To identify companies that align with their goals and achieve the highest levels of financial performance.
How do accounting principles help in analyzing and understanding financial statements?
Accounting principles are the foundation upon which analysts can rely: to understand and analyze financial data accurately and effectively; So here are some ways to help:
- Accurate Tracking: Accounting principles guide accountants to accurately track expenses and revenues. This enables analysts to analyze financial data correctly.
- Financial reports: They also contribute to preparing important financial reports, such as income statements, budgets, and cash flow statements. Which provides valuable information.
- Financial Inferences: Used to develop the ability to draw financial inferences from financial statements; thus, information about the company’s financial condition can be inferred.
Benefits of financial accounting principles for the company
Accounting principles represent the basis for providing accurate and transparent financial information. It is worth noting that these principles are characterized by several main features, including:
- Friendship: It aims to build trust with the public and stakeholders by providing accurate and reliable information about the company’s financial results.
- Occupational health includes standards and principles that must be followed professionally and honestly. To ensure the accuracy and reliability of financial information.
- Comprehensiveness: covers all financial aspects of the company, including financial transactions, reports, and auditing.
- Accuracy: Strives to achieve accuracy in presenting financial information through careful review of financial details.
- Transparency aims to ensure transparency in providing financial information to the public, which makes it easy for everyone to understand based on general accounting principles.
What are the elements of financial accounting?
It is a set of elements that the accountant must follow in carrying out his work, which are as follows:
Principles of regularity
This principle relates to adherence to accounting rules and recognized methods in the accounting field and aims to ensure regular and systematic recording of financial transactions in order to ensure credibility and transparency in financial account reports.
Example
Let’s say there’s a delivery company that buys industrial land somewhere to use for repair jobs and a parking lot for trucks that it doesn’t use on time. Within a few years, this area is declared developable, and everyone starts building houses right next to it.
If we analyze the company’s balance sheet, we must keep in mind that the benefit of the land remains the same: maintenance of the business trucks, but if the company is liquidated one day and that land has to be sold, its value will be very different from what is reflected in accounting.
accrual principle
This principle stipulates that financial transactions are recorded based on their occurrence and not on the availability of cash. In other words, when a business transaction occurs, it must be recorded as soon as it occurs, even if the cash has not yet been received. It is worth noting that this includes recording revenues and deferred expenses.
Example
Suppose there is a company that hired a marketing expert on July 1, 2020, for a campaign that will last for a year. On that day, you receive the invoice and pay the amount of 6,000 Saudi riyals, and even though the company pays 6,000 Saudi riyals in 2020 AD, it must be calculated as expenses of 3,000 Saudi riyals (six months) in 2020 AD and 3,000 Saudi riyals (six months) in 2021 AD. Therefore, on December 31, 2020, expenses will accumulate.
Conservatism Principle
This principle relates to precaution and caution in estimating income and costs, as well as in evaluating assets and liabilities, and calls for recording expected losses in advance and postponing recording profits until they are actually realized. The principle also aims to ensure that profits are not inflated and that values are estimated realistically and appropriately.
Example
A company terminates its relationship with a commercial agent and compensates him with an amount of 50,000 Saudi riyals, which is equivalent to two years of commission income, but the agent considers that the compensation is insufficient and demands before the courts the amount of 100,000 Saudi riyals, which is equivalent to four years. The company believes that it is very likely that it will lose the lawsuit and estimates that it will have to pay the agent 100,000 riyals. You will therefore record expenses for this amount, pending what the ruling dictates later.
Historical cost principle
This principle is based on recording assets and liabilities at their value at the time of the original purchase or transaction, and according to it, the assets are not re-evaluated periodically, but depreciation is calculated according to the original value of the assets, as it aims to maintain balance and stability in accounting reports over time.
Example
A joint-stock company issues invoices to the accounts of two million turkeys in January 2021 to pay a meal for one of its 40 workers in the amount of 10 turkeys in December. So what should the company do? By applying the historical cost principle, the company can dispense with making the accounting adjustment and record it as an expense for the current year.
The principle of invariance of methods
This principle stipulates the use of consistent and consistent accounting methods in recording financial transactions; in other words, when you choose an accounting method to value assets or calculate income, it should continue to be used consistently without frequent changes. Thus, it aims to achieve balance and comparison between different accounting periods.
Example
In 2020, a company will adopt the weighted average price as a standard for evaluating its warehouse stocks. Could we then switch to the LIFO method in 2021 (last in, first out), under which the last goods to enter the warehouse are the first to go out? No, because it will affect the warehouse valuation unless the circumstances that led to the adoption of the previous average price criterion change.
The principle of clarity
The principle of clarity is one of the elements of financial accounting and indicates the necessity of presenting financial information in a clear and understandable manner to users. It is worth noting that financial reports and accounting data must be clearly understandable and interpretable so that users are able to make correct financial decisions based on that information.
Example
Imagine that a bank gives a loan to a company, and it obviously has to bear the periodic payment of interest. In addition, the company has a fixed-term economic sum in the bank itself and in fact gets a certain interest thanks to it. So can it then offset the interest expense on the loan with the interest income of the term funds? According to the principle of clarity, the answer is no; you can’t.
Conclusion
In a world full of financial complexities and ongoing economic challenges, financial accounting principles remain a crucial reference for the success of companies and institutions in achieving their financial goals, as understanding and applying these principles correctly represents the basic foundation for making smart financial decisions and building sustainable businesses. Because it is a powerful tool that helps provide transparency and reliability in financial reports and contributes to building confidence between investors and all parties to the economic process, it is worth noting that it directs us towards recording and evaluating assets, liabilities, and financial operations in an accurate and reliable manner. This enables us to understand the actual financial performance of companies, make strategic decisions based on real and reliable numbers, and also helps us deal with compliance issues and complex financial and tax legislation.
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