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Every business needs to have a strong accounting system in place so that they can understand their finances and make accurate projections about the direction of their companies. Accounting involves continuously observing and exercising control over your company’s economic activities. The success of your business will largely depend on your accounting, and it’s important for your company to strictly follow the generally accepted accounting principles (GAAP) in your accounting practices.

As a discipline, accounting is strict and follows the GAAP to prevent inaccurate or incomplete information from being reported. Here is what to know about modern accounting and the five generally accepted accounting principles from the professionals at TMD Accounting.

Principle 1: Revenue Recognition

The revenue recognition principle is the first principle your business should know. When you record data, you need to think about the time during which you recognize revenues your company earns through its income statements. When you will recognize your revenues will depend on whether your company uses the cash-basis or accrual-basis method of accounting. If you are using the cash-basis method, you will recognize your revenues during the period in which your company receives them. If you are using the accrual-basis method, you will recognize your revenues during the period in which you provide services.

The revenue recognition principle states that companies should only recognize revenues when they have mostly or totally completed the process of earnings. This means you should record revenues at the time when the purchaser takes possession or when you have completed your service. The revenue recognition principle helps businesses to keep accurate track of their accounts and prevents them from counting profits too early.

Principle 2: Cost

Businesses should also record their assets at the time they purchase a service or product to accurately track their expenses. YOu should record the cost of anything on which your business spends money and properly account for depreciation. Under the cost principle, businesses should not record the resale cost of items in their books. You should instead use the item’s historical cost. For example, if you own an office, use the historical cost of the property instead of its fair market value while making certain to account for overhead costs.

Principle 3: Matching

Businesses should make sure they match the revenues they have recognized with their expenses during the same period and record them when the expenses were incurred. If your business recognizes revenues for services or products you sold, you should also recognize the cost of those services or products during the same period.

Every expense item should match a revenue item under the matching principle. For example, if you sell t-shirts, you should recognize the revenue of a t-shirt when a customer purchases it while also accounting for the expense involved in your business purchasing the item at its wholesale price. When you apply the matching principle, you are using the accrual-basis method of accounting.

Principle 4: Full Disclosure

When your business creates its financial statements, all of the information must be complete and transparent. You should not include any information that is misleading so that your clients or partners are aware of all relevant information about your company.

Prinicple 5: Objectivity

At all times, your accounting information should remain accurate and free from opinions. You should make sure your accounting data is supported by evidence, including receipts, invoices, and vouchers. When you remain objective, your financial reports will be more reliable. You should steer clear of anything that could call your work into question because of your subjective opinion.

Under the objectivity principle, your books should include verifiable information that is supported by objective evidence and should not include any unsupported data. The values used in your reports should not be subjectively measured even when subjective data is more favorable than the data that can be verified. If you violate this rule, it could lead to confusion because of making it difficult to comprehend the subjective data. It is best to only include data that others can verify in your financial reports.

Why Is It Important for Businesses to Know Accounting Principles?

The five generally accepted accounting principles are justified, and they provide a good foundation for your company’s budgeting and planning processes. By strictly adhering to these five principles, you can avoid conjectures that could lead to financial problems.

Following basic accounting principles can also help to improve the cohesiveness of your organization. Depending on your business’s size, different employees might be in charge of different accounting principles. If you don’t have a plan, it could be impossible for your employees to perform their jobs so that you can get a clear picture of your business’s financial health. If left unchecked, this can result in significant financial problems and potential business failure. Making sure your plan is founded on the five generally accepted accounting principles can help to avoid these types of issues.

The basic principles of accounting provide a straightforward method for reporting your finances. Each principle has a role in the big picture of your company’s financial health. When you establish these principles at your business, you can facilitate a more productive and organized environment to track your cash flow and avoid problems such as unverified data and missing funds.

Find an Accountant for My Small Business

When you work with TMD Accounting, we can help you establish the generally accepted accounting principles at your business to facilitate your company’s growth and success. To learn more, call us today at 1-856-228-2205.