Rules of The Accounting “Game”
In addition to the revenue realization and matching principles or concepts, accounting and bookkeeping is guided by some additional underlying rules.
Why Have Rules ?
All games such as football, baseball, basketball, etc. 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 (FASB) and the International Accounting Standards Board (IASB). 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.
The following are some of the Rules used to “play” the Accounting “Game”:
Accrual Concept (discussed earlier)
Supports the idea that income and expenses should be measured and recorded at the time major efforts or accomplishments occur rather than when cash is received or paid.
Revenue Realization Concept (discussed earlier)
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 (discussed earlier)
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.
Accounting Period Concept
This assumption assumes that business operations can be recorded and separated into different time periods such as months, quarters, and years. This is required in order to provide timely information that is used to compare present and past performance.
Money Measurement Concept
This assumption assumes accounting measures transactions and events in money and only transactions that can be monetized (stated in a monetary unit such as the dollar) are recorded and presented in financial statements. Simply stated, money is the common denominator (measurement unit) used for reporting financial information.
Business Entity Concept
This assumption requires every business to be accounted for separately from the owner. Personal and business-related transactions are kept apart from each other. In other words, the separate personal transactions of owners and others are not commingled with the reporting of the economic activity of the business. One of the first recommendations almost all accountants tell a client is to at least establish a business checking account and to use it to only record their business transactions.
Going Concern Concept
This assumption assumes that a business will continue operating and will not close or be sold. It assumes that a business will be in operation for a long time. Based on this assumption, actual costs instead of liquidation values are used for presenting financial information. This assumption is abandoned in the event that a business is actually going out of business.
This principle requires that most assets are recorded at their original acquisition cost and except for a relatively few exceptions (marketable securities) 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. See Conservatism Concept.
Revenues and gains are recognized slower and expenses and losses are recognized quicker.
Accountants have a tendency to stray away from painting too rosy a picture. In other words, if in doubt, err to the side of caution. While accountants don’t want to misinform users of financial information, they also don’t want to be sued.
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.
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.
The significance and importance of an item should be considered in order to determine what is reported. Insignificant events need not be measured and recorded.
The benefit of providing the financial information should also be weighed against the cost of providing it.
Industry Practices Convention
When customary industry practices exists they should be followed and used for financial reporting.
All lessons and examples in the remainder of this tutorial are all based on the accrual method of accounting , the double entry method of bookkeeping, and the sole proprietor type of business organization.
I'm not going to ring the bell on you; but, when you feel ready after the Videos and Tests move on to Learning The Bookkeeping Terminology