Ground rules of accounting that are followed in preparation of all accounts and financial statements

Ground rules of accounting that are (or should be) followed in preparation of all accounts and financial statements.

The four fundamental concepts are (1) Accruals concept: revenue and expenses are taken account of when they occur and not when the cash is received or paid out; (2) Consistency concept: once an entity has chosen an accounting method, it should continue to use the same method, except for a sound reason to do otherwise.

Any change in the accounting method must be disclosed; (3) Going concern: it is assumed that the business entity for which accounts are being prepared is solvent and viable, and will continue to be in business in the foreseeable future; (4) Prudence concept: revenue and profits are included in the balance sheet only when they are realized (or there is reasonable ‘certainty’ of realizing them) but liabilities are included when there is a reasonable ‘possibility’ of incurring them also called conservation concept.

Other concepts include (5) Accounting equation: total assets of an entity equal total liabilities plus owners’ equity; (6) Accounting period: financial records pertaining only to a specific period are to be considered in preparing accounts for that period; (7) Cost basis: asset value recorded in the account books should be the actual cost paid, and not the asset’s current market value;

(8) Entity: accounting records reflect the financial activities of a specific business or organization, and not of its owners or employees; (9) Full disclosure: financial statements and their notes (footnotes) should contain all pertinent data;

(10) Lower of cost or market value: inventory is valued either at cost or the market value (whichever is lower) to reflect the effects of obsolescence; (11) Maintenance of capital: profit can be realized only after capital of the firm has been restored to its original level, or is maintained at a predetermined level;

(12) Matching: transactions affecting both revenues and expenses should be recognized in the same accounting period; (13) Materiality: relatively minor events may be ignored, but the major ones should be fully disclosed; (14) Money measurement: accounting process records only those activities that can be expressed in monetary terms (with some exceptions, as in cost-accounting);

(15) Monetary measurement: only the activities measurable in terms of money should be recorded;

(16) Objectivity: financial statements should be based only on verifiable evidence, comprising an audit trail; (17) Realization: any change in the market value of an asset or liability is not recognized as a profit or loss until the asset is sold or the liability is paid off (discharged); (18) Unit of measurement: financial data should be recorded with a common unit of measure (dollar, pound sterling, yen, etc.).