5 Important Principles of Modern Accounting
Whether you’re in the business of selling widgets, providing cleaning services, tending to animals, or manufacturing industrial equipment, your business operates under the same basic principles of modern accounting. These principles are generally accepted practices of accounting, which became commonplace in the 1800’s, though the original concepts are as old as ancient Mesopotamia. The world of accounting took great strides with the treatise of bookkeeping, published by Luca Pacioli in 1494 within a book entitled, Summa de Arithmetica, Geometria, Proportioni et Proportionalita. These five basic principles form the foundation of modern accounting practices.
1. The Revenue PrincipleThis principle defines a point in time when bookkeepers may record a transaction as revenue on the books. The revenue principle states that revenue for the business is earned and recorded at the point of sale. This means that revenue occurs at the time at which the buyer takes legal possession of the item sold or the service is performed, not at the moment at which cash for the transaction is accepted by the seller. This concept is sometimes called the “revenue recognition principle.”
2. The Expense PrincipleThis principle defines a point in time at which the bookkeeper may log a transaction as an expense in the books. The expense principle, or expense recognition principle, states that an expense occurs at the time at which the business accepts goods or services from another entity. Essentially, it means that expenses occur when the goods are received or the service is performed, regardless of when the business is billed or pays for the transaction.
3. The Matching PrincipleThe matching principle states that you should match each item of revenue with an item of expense. For example, if you are selling tacos, you could count the expense of the shells, meat, and toppings at the time at which a customer buys the taco. In other words, you match the expense of the taco ingredients with the revenue earned from the sale of the taco. When a business applies the revenue, expense, and matching principles in practice, they are operating under the accrual accounting method.
4. The Cost PrincipleThe cost principle states that you should use the historical cost of an item in the books, not the resell cost. For example, if your business owns property, such as real estate or vehicles, those should be listed as the historical costs of the property, not the current fair market value of the property.
5. The Objectivity PrincipleThe objectivity principle states that you should use only factual, verifiable data in the books, never a subjective measurement of values. Even if the subjective data seems better than the verifiable data, the verifiable data should always be used. In addition to these basic principles, the accounting world operates under a set of assumptions, or things that accountants can assume to always be true.
