Fundamental Accounting Principles: A Comprehensive Look
Fundamental Accounting Principles
Equity
The equity between competing interests must be a constant concern in accounting, since those who use accounting data may find that their particular interests are in conflict. It follows that financial statements should be prepared in such a way that they fairly reflect the different interests at stake in a firm or individual enterprise.
Entity
Financial statements always refer to an entity, where the subjective element is considered proprietary or a third party. The concept of “entity” is different from “person,” as one person can produce financial statements of several “entities” that they own.
Real Economic Assets
Financial statements always refer to economic assets, i.e., tangible and intangible assets that have economic value and are thus capable of being valued in monetary terms.
Account Currency
Financial statements reflect assets in a way that is used to reduce all components to a heterogeneous group, allowing for easy comparison. This is achieved by choosing an accounting currency and valuing the assets and liabilities using a “price” for each unit. Generally, the money that is legal tender in the country within which the “entity” operates is used as the money of account, and in this case, the “price” is given in units of legal tender. In cases where the currency is not a stable standard of value, due to fluctuations, the validity of the underlying principle is not altered, as correction is feasible through the application of appropriate adjustments.
Existing Business
Unless expressly stated otherwise, it is understood that the financial statements belong to a “going concern,” considering that the concept that informs the above expression refers to the entire economic body whose existence is truly valid and has a future projection.
Cost Valuation
The value of purchase or production cost is the primary and basic valuation approach, which determines the development of the financial statements called “progress,” also in correspondence with the concept of “going concern.” This is why this rule takes on the character of a principle. This statement does not mean ignoring the existence and validity of other rules and criteria applicable in certain circumstances. On the contrary, it claims that in the absence of special circumstances justifying the application of another criterion, “cost” should prevail as a basic valuation concept. Moreover, fluctuations in the value of the currency of account, with their attendant corrective changes affecting the monetary figures or the cost of certain assets, are also not alterations to the expressed principle but, in substance, are mere adjustments to the expression of the respective costs in numerical terms.
Fiscal Year
In business, it is necessary to measure the results of management from time to time, either to meet administrative, legal, or tax reasons or to meet financial commitments, and so on. It is a condition that the periods are of equal duration so that the results of two or more fiscal years are comparable.
Property Variations
Property variations should be considered when setting the economic results that fall within the fiscal year, without considering whether they have been charged or paid.
Objectivity
Changes in assets, liabilities, and the accounting term equity should be formally recognized in the accounting records as soon as it is possible to measure them objectively and express that measurement in the money of account.
Realization
Economic results should only be counted when realized, or when the originating operation is perfected from the point of view of applicable legislation or trade practices, and essentially all the risks inherent in such an operation have been considered. Generally, it must be established that the term “realized” is part of the accrual concept.
Prudence
Prudence means that when one must choose between two values for an asset, one should usually choose the lowest, or that a transaction should be accounted for in such a way that the owner’s portion is less. This general principle can also be expressed by saying, “account for all losses when they are known and gains only when they are realized.” Exaggeration in the application of this principle is not suitable if it is detrimental to the fair presentation of financial position and results of operations.
Uniformity
The general principles, when applicable, and the specific rules used to prepare the financial statements of a given entity should be applied uniformly from one year to another. The effect on the financial statements of any relevant changes in the application of general principles and specific rules should be noted in an explanatory note. However, the principle of uniformity should not lead to maintaining unchanged those general principles, when applicable, or specific rules that should be amended as required by the situation.