Accounting is an essential part of every business. Accuracy and proper management of the accounting function affect the business’s future in the market. Therefore, it is necessary to have an appropriate system to manage the accounting function. It is the reason why accounting principles and standards came into existence. Accounting principles and standards provide a framework for accounting and set rules for maintaining financial books, preparing financial statements, and furnishing financial analysis reports. A combination of both accounting principles and accounting standards determines how a business must handle its accounting function. Both are crucial and different aspects of the accounting process. Let us know more about them here.
Accounting principles can be defined as the fundamental principles that lay down the framework to be followed by businesses for their accounting. These principles also serve as the basis for accounting standards formulation. Some basic and most commonly used accounting principles include:
• Going concern principle
• Economic entity principle
• Accrual principle
• Matching principle
• Historical cost principle
• Full disclosure principle
• Consistency principle
• Revenue recognition principle
• Materiality principle
• Conservatism principle
• Cost-benefit principle
• Objectivity principle
Accounting Standards are rules that businesses must apply to measure, value, present, and disclose accounting information. These policies and practices help prepare financial statements, and financial analysis reports are done strictly by following the accounting standards. External parties like investors, banks, and regulatory authorities rely on the accounting standards for accuracy and transparency in the business’s financial information.
Accounting principles work as a basis for the formation of accounting standards. Accounting principles are the concepts that define the basis of the accounting process. At the same time, accounting standards are the rules that define how the accounting records and reports are prepared and managed. Following are some differences between the two:
i. These are customary and flexible in nature
ii. Businesses have the liberty to follow various methods
iii. These create less responsible than the accounting standards
iv. These have multiple aspects and theoretical and practical purposes
v. Some examples of accounting principles are the accrual principle, full disclosure principle, going concern principle, etc.
i. These are uniform rules and are rigid in nature
ii. Businesses should follow these standards
iii. These create more responsibilities
iv. Their primary objective is accurate measurement and disclosure
v. Some examples of accounting standards are IFRS 9 Financial Instruments, IFRS 10 Consolidated Financial Statements, IAS 38, Intangible Assets, etc.
Accounting principles are similar for every business worldwide. However, many countries have their regulatory bodies for accounting standards. Every regulatory body derives the accounting standards either from IFRS or GAAP.
IFRS vs GAAP
GAAP (Generally Accepted Accounting Standards) is a combination of accounting principles, accounting standards, and procedures issued by FASB (Financial Accounting Standards Board). It is most widely used for preparing a business’s financial statements and financial analysis reports. In the USA, all public companies must adhere to GAAP standards. However, many private companies follow these to provide transparency in their books. Besides the USA, many other countries follow GAAP for accounting standard compliances.
IFRS (International Financial Reporting Standards) is used by international companies for financial reporting. IFRS provides guidelines to non-US GAAP companies and is set up by IASB (International Accounting Standards Board). The main objective of IFRS standards is to bring consistency and transparency to accounting practices and standards, irrespective of the company or country.
1. Methodology- IFRS is principle-based and considers the overall patterns. On the other hand, GAAP is rule-based and focuses on research.
2. Revenue recognition- As per IFRS standards, revenue is equal to the cost, whereas revenue is recognised as per the completed contract method under GAAP.
3. Extraordinary items- Extraordinary items do not have any special distinction under IFRS. However, GAAP allows representing extraordinary or unusual items separately in the income statement.
4. Fixed assets- The valuation method of fixed assets like property, plants, and equipment varies under IFRS and GAAP. While IFRS allows the valuation of fixed assets under the cost model or revaluation model, GAAP values fixed assets only under the cost model.
5. Investment property- IFRS treats investment properties under a separate standard, i.e., IAS 40. On the other hand, investment properties are treated under the plant, property, and equipment unless they can be classified as ‘held-for-sale’ property.
6. Intangible assets- IFRS values intangible assets based on whether they will have any future economic benefit. However, GAAP measures intangible assets based on their fair market value.
7. Inventory valuation method- IFRS uses FIFO (First-in, First-out) and weighted average cost method for inventory valuation. GAAP uses LIFO (Last-in, First-out), FIFO (First-in, First-out), and the weighted average cost method to value inventory.
8. Inventory reversal- Under IFRS, the amount of inventory write-down can be reversed, whereas the amount of inventory write-down cannot be reversed under GAAP.
9. Development cost- Research and development costs are capitalised under IFRS. In the case of GAAP, the research and development costs cannot be capitalised.
Accounting Principles and Accounting Standards both are crucial for the accounting process. They bring consistency, transparency, and efficiency in preparing the accounting books, finalising the financial statements, and preparing financial analysis reports for the businesses. When businesses use online accounting outsourcing services to handle the accounting function, following accounting principles and standards ensure compliance with the regulations. It also helps keep track of the transactions and treatment of assets and liabilities of the business. The framework provided by the accounting principles and standards makes it easy to understand and compare the businesses’ financial information around the work.