Accounting Assumptions and Principles

Accounting principles are built on a foundation of a number of basic concepts. One of them is known as the consistency principle. Companies can choose their accounting policies – … (1)…. But in choosing accounting policies they have to be consistent – which means using the same methods every year, unless there is a good reason to change a policy. The policies have to be disclosed to the shareholders in the “Statement of Accounting Policies” included in the Annual Report.

The historical cost principle states that companies …(2)… and not their (estimated) current selling price or replacement cost. The current price is not important if the business is a going concern – a successful company that will continue to do business – as its assets are not going to be sold, or …(3)…. Some countries with regular high inflation use replacement cost accounting, which values all assets at their current replacement cost – the amount that would have to be paid to replace them now.

Other accounting principles are as follows. The full-disclosure principle states that … (4)…. The principle of materiality says that very small and unimportant amounts do not need to be shown. The principle of conservatism (prudence) is that …(5)…, you choose the one that is least likely to overstate or over-estimate assets or income. The objectivity principle says that accounts should be based on facts and not on personal opinions or feelings. The revenue recognition principle is that revenue is recognized in the accounting period in which it is earned. This means the revenue is recorded … (6)…, not when they are paid for. The matching principle states that each cost or expense related to revenue earned must be recorded in the same accounting period as the revenue it helped to earn.