Accounting Principles
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What are accounting principles?
Accounting principles are standardized guidelines for financial reporting and accounting practices. They include rules and concepts that ensure consistency, transparency, and accuracy in financial statements.
Why are accounting principles important?
Accounting principles ensure consistency, transparency, and accuracy in financial reporting, which is vital for stakeholders to make informed decisions, compare financial data across periods, and maintain regulatory compliance.
What is the revenue recognition principle?
The revenue recognition principle dictates that revenue should be recorded when it is earned, regardless of when payment is received. This ensures income is matched with the period it relates to.
What is the expense recognition principle?
The expense recognition principle, or matching principle, states that expenses should be recorded in the same period as the revenues they helped generate. This matches costs with related income.
What is the historical cost principle?
The historical cost principle requires companies to record assets at their original purchase cost, rather than their current market value. This provides a stable and reliable record of asset value.
What is the going concern principle?
The going concern principle assumes a company will continue to operate indefinitely, allowing the deferral of some expenses into future periods based on the expectation of continued operation.
What is the economic entity principle?
The economic entity principle states that a business’s transactions should be separate from its owner’s personal transactions and those of other businesses to provide clear financial information.
What is the monetary unit principle?
The monetary unit principle requires that all recorded financial transactions should be expressed in a stable currency, without adjusting for inflation, ensuring uniform and comparable financial reporting.
What is the full disclosure principle?
The full disclosure principle mandates that financial statements should include all information necessary for users to understand the true financial position and results of a company.
What is the conservatism principle?
The conservatism principle advises accounting for potential losses or liabilities when they are probable but not recognizing potential gains until they are realized, ensuring prudent financial reporting.
What is the accrual basis of accounting?
Accrual basis accounting recognizes financial events when they occur, not when cash is exchanged. This approach provides a more accurate financial picture by matching revenues and expenses in the same period.
What is the cash basis of accounting?
Cash basis accounting records revenue and expenses only when cash is received or paid. While simple, it may not accurately reflect a company's financial position due to timing differences.
What is double-entry accounting?
Double-entry accounting involves recording each financial transaction in two accounts: one debit and one credit. This system helps maintain the accounting equation and ensures accuracy in financial records.
What is the matching principle in accounting?
The matching principle requires that expenses be recorded in the same period as the revenues they help generate, aligning costs with related income for accurate financial reporting.
What is the time period principle?
The time period principle allows financial activities to be reported in shorter, specific periods such as quarters or years, enabling timely and specific analysis of a company's performance.
What is the significance of GAAP?
Generally Accepted Accounting Principles (GAAP) are standardized guidelines for financial reporting in the U.S., ensuring consistency, reliability, and comparability across companies and industries.
What is IFRS?
International Financial Reporting Standards (IFRS) are global accounting standards that aim to make financial statements consistent, transparent, and comparable across international boundaries.
How do GAAP and IFRS differ?
GAAP is rule-based with specific guidelines, while IFRS is principle-based, allowing more interpretation. Key differences include treatment of inventory, revenue recognition, and certain financial instruments.
What is a balance sheet?
A balance sheet is a financial statement that reports a company's assets, liabilities, and shareholders' equity at a specific point in time, providing insights into its financial condition.
What is an income statement?
An income statement, also known as a profit and loss statement, summarizes a company's revenues, expenses, and profits over a specific period, showing its financial performance and profitability.
What is a statement of cash flows?
A statement of cash flows outlines a company's cash inflows and outflows over a period, categorized into operating, investing, and financing activities, revealing its liquidity and financial flexibility.
What is an owner's equity?
Owner's equity, also known as shareholder's equity, represents the owners' residual interest in a company's assets after deducting liabilities, indicating the net worth of the business.
What is depreciation?
Depreciation is the systematic allocation of the cost of a tangible asset over its useful life, reflecting the wear and tear and consumption of the asset over time.
What is amortization?
Amortization refers to gradually writing off the initial cost of an intangible asset over its useful life, or the repayment of loan principal over time through scheduled payments.
How are prepaid expenses treated in accounting?
Prepaid expenses are payments made in advance for goods or services to be received in the future, recorded as current assets, and expensed over the period benefited.
What is a ledger in accounting?
A ledger is a comprehensive record of all a company's financial transactions, organized by account. It is the principal book used to prepare financial statements.
What is a journal entry?
A journal entry is a record of a business transaction in an accounting journal, showing specific accounts affected, the amounts debited and credited, and a brief description.
What is inventory in accounting?
Inventory refers to the goods available for sale and raw materials used to produce them, recorded as a current asset on the balance sheet, critical for cost of goods sold calculation.
What is retained earnings?
Retained earnings are the cumulative amount of net income left in a company after dividends are paid to shareholders, reflecting the reinvestment in the business or reserved funds.
What is a trial balance?
A trial balance is a worksheet listing all ledger accounts and balances at a particular date, ensuring that total debits equal total credits, verifying arithmetic accuracy in bookkeeping.
How is bad debt expense recorded?
Bad debt expense, estimated based on uncollectible accounts, is recorded as an expense and typically offset by a provision called an allowance for doubtful accounts, reducing accounts receivable.
What is a fiscal year?
A fiscal year is a one-year period companies use for accounting purposes and financial reporting, which may or may not align with the calendar year, often chosen for operational convenience.
What is the purpose of an audit?
An audit is an independent examination of financial statements to ensure accuracy, compliance with regulations, and honest presentation, providing assurance to stakeholders about a company's financial health.
What is a contingent liability?
A contingent liability is a potential financial obligation that may occur depending on the outcome of a future event, disclosed in financial statements if probable and measurable.
What is goodwill in accounting?
Goodwill is an intangible asset arising when a company acquires another at a premium over the fair value of its net identifiable assets, reflecting future economic benefits.
How is foreign exchange handled in accounting?
Foreign exchange is recorded by converting transactions denominated in foreign currencies to the company's functional currency using exchange rates, while exchange rate differences are recognized in income or equity.
What is the equity method of accounting?
The equity method is used to account for investments in associates where the investor has significant influence, recording its share of the investee’s net income in its financial statements.
What are intangible assets?
Intangible assets are non-physical, identifiable resources such as patents, trademarks, and goodwill, providing future economic benefits, recorded at cost, and often amortized over their useful lives.
How is a capital lease recorded?
A capital lease is recorded as an asset and a corresponding liability on the balance sheet, reflecting ownership-like rights and obligations, with lease payments reducing the liability and interest.
What is a deferred tax liability?
A deferred tax liability arises when taxable income is less than accounting income due to temporary differences, indicating future tax payments, recorded as a liability on the balance sheet.
What is the cost principle?
The cost principle mandates that assets be recorded at their original cost when acquired, providing objective, verifiable data in financial records despite fluctuations in market value over time.
What is a solvency ratio?
Solvency ratios are financial metrics used to assess a company's ability to meet long-term obligations, comparing its total debt to assets or equity, indicating financial stability.
How is inventory valued in accounting?
Inventory can be valued using methods like FIFO (First-In, First-Out), LIFO (Last-In, First-Out), or weighted average cost, reflecting different cost flow assumptions and impacting financial results.
What is a cash equivalent?
Cash equivalents are short-term, highly liquid investments that are readily convertible to known cash amounts, with original maturities of three months or less, offering minimal risk of value changes.
What is a provision in accounting?
A provision is a liability of uncertain timing or amount, recorded to account for a future obligation based on past events, following reasonable estimation under conservative assumptions.
What is the difference between accounts payable and accounts receivable?
Accounts payable are amounts a company owes to suppliers and creditors, representing short-term liabilities, while accounts receivable are amounts owed to the company by its customers, shown as current assets.
What is a journal in accounting?
A journal is a chronological record of all financial transactions, documenting details like date, accounts involved, amounts debited and credited, providing the basis for ledger postings.
What are financial statements?
Financial statements are formal records summarizing a company’s financial activities, including the balance sheet, income statement, and cash flow statement, providing insights into its financial condition and performance.
What is a fixed asset?
Fixed assets are long-term tangible assets like land, buildings, and machinery used in operations, not intended for sale, providing economic benefits over multiple periods, recorded at cost and depreciated.