Concepts of Accounting Principles and Accounting Equation

Every day, each one of us makes use of Accounting Principles and this is true irrespective of the profession of the person. We pay for some services e.g. buying vegetables, paying electricity bills, etc. and in return, we get the services for which we have paid the money. Knowingly or unknowingly, we use the basic Accounting Principles in our day to day lives.

The two basic building blocks of any financial transaction are Income and Expense. We pay to a particular party/person in exchange for some goods/services. This is the basis ofDebitandCreditin the accounting system. This is how the double-entry system got its name. Just imagine a hypothetical situation where the consumer/customer follows one type of accounting principle and the recipient follows a different type of accounting principle. There would be chaos and the two parties can never arrive on a common consensus.

Basic Accounting Equation

As per the basic accounting equation, Debit always equates to the credit and the sum of equities & liabilities always equates to Assets. Accrual accounting and double-entry accounting system are based on the two equations which are a part of the basic accounting equation:

Equation 1 – Assets = Liabilities + Equities

Equation 2 (Expanded Accounting Equation) – Equation 1 + Secondary equation (Debit = Credit)

Types of Accounting Equations

Financial accounting system is based on the accounting equation which is also called the ‘Balance Sheet Equation’. The important basic accounting equations are mentioned below:

Asset = Liability + Capital

(Assets of the business are supported via loans or external funding or sponsored using owner’s equity)

Liabilities= Assets – Capital

(The difference between the assets owned and investment by the owner in the business is considered as liabilities to the business).

Owners’ Equity (Capital) = Assets – Liabilities

(This equation indicates the value of the assets that are owned by the company).

Financial Accounting

To avoid chaos with regards to financial accounting, a general body named Indian Accounting Standard (Ind-AS) was established in the year 1977 and it is the accounting standard adopted by the companies in India. The financial transactions for large enterprises (including emerging SME’s) would run into millions of Rupees and accounting financial statements should capture & communicate these records to the key stakeholders of the company so that can arrive at important decisions.

The norms or principles on which financial statements are made do not change from one enterprise to another. That is why the entire accounting process is applied with the framework of ‘Generally Accepted Accounting Principles’ (GAAPs). Principles of accounting are the building blocks on which the entire accounting system is developed.

Benefits of Accounting Principles

As mentioned in the Indian Accounting Standards, accounting principles are of vital importance as it provides the following information:

  1. Categorize a particular item as expense, income, asset or liability.
  2. Information is presented in a consistent manner.
  3. Proper information about the amount that will be recognized in the account books.
  4. Present the information in a unified manner that reflects in the Balance Sheet or P&L statement.
  5. Proper disclosures (if any) to be made about the items that are a part of the Balance Sheet.

Since a unified language is used in financial statements due to the implementation of accounting principles, it makes comparison of financial statements easier.

Key Accounting Principles

Some of the key accounting principles are mentioned below:

  • Accrual Principle – Accounting transactions should be recorded for the accounting periods during which they have occurred and not adjusted for the period when cash-flow is associated with them.
  • Going Concern Principle – Any entity has an intention to continue its operations for the future.
  • Consistency Principle – According to this concept, a particular accounting principle should be used till the time a better method or principle is implemented.
  • Conservative Principle – Liabilities & expenses should be recorded when they occur whereas revenues & assets should be recorded only when you are sure that they will occur.
  • Revenue Recognition Principle – As stated in the Accounting Standard 9, revenue should not be recognized when the amount is received.
  • Matching Principle – According to this concept, expenses should be recognized & recorded when you can match those expenses against the revenues derived while incurring those expenses.

Irrespective of the size of the company, it is important to choose the right kind of accounting software that is easy to use and adheres to these basic accounting principles.

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