Business Consulting - 5 Basic Accounting Principles Commonly Forgotten by Start-Ups

Updated: Jul 31, 2021

Busienss Consulting for business start ups
This busines consulting article is based on a beginner to intermediate understanding of accounting principles. If you are not well versed in accounting, this article is not meant to provide you training on accounting. It is meant to make you aware of what your accountant may need to focus on as the foundation of your business.

In the United States, accounting standards are called Generally Accepted Accounting Principles, GAAP.

GAAP helps govern the world of accounting in accordance with general rules and guidelines. It tries to standardize and regulate the definitions, assumptions, and methods used in accounting across all industries. GAAP covers topics such as revenue recognition, balance sheet classification, and materiality.

The ultimate goal of GAAP is to ensure the company's financial statement's completeness, consistency, and comparability. It makes it easier for investors to analyze and extract useful information from a company's financial statements, including trend data over a specific period. It also makes it easier to compare financial data across companies.

The main list of GAAP accounting principles developed by the International Committee of Accountants and operating within the framework of the International Accounting Standards (IAS) looks like this:

1. The principle of two (Dual-aspect concept). The sum of the company's funds is always equal to the sum of its liabilities and capital.

2. The principle of monetary measurement (Money-measurement concept). Accounting reports include only those data that can be monetary.

3. The principle of enterprise autonomy (Entity concept). Under the International Accounting Standards (GAAP, IAS), the accounts of the company must be separated from the accounts of its owners or employees.

4. The principle of continuity (Going-concern concept). The concept of continuity of International Accounting Standards (GAAP, IAS) is based on the fact that an enterprise will continue to operate indefinitely unless there is evidence to the contrary.

5. Cost concept. In accounting in accordance with the principle of the cost of the International Accounting Standards (GAAP, IAS), they operate with the cost of funds and not with their market value.

6. The principle of conservatism (Conservatism concept). In accordance with the principle of conservatism, income represents an increase in the company's capital, and accounting does not record an increase in the capital until the transaction becomes a well-defined event (for example, the shipment or delivery of goods). Similar considerations apply to capital depletion.

7. The principle of materiality (Materiality concept). According to the principle of the materiality of the International Accounting Standards (GAAP, IAS), non-essential transactions should not be taken into account in accounting.

8. The principle of implementation (Realization concept). In accordance with the principle of implementation of International Accounting Standards (GAAP, IAS), revenues are recorded by the company when its products are delivered to the consumer and services - at the time they are provided to the client.

9. Matching concept. Under the principle of compliance with International Accounting Standards (GAAP, IAS), the income tax cost shown in the income statement must be equal to the tax calculated based on the accountant's Terek profit.

10. The principle of accrual accounting (Accrual principle). This principle means that to account for the company's operations:

  • not only transactions that are related to money are recorded, but also barter, credit sales, exchange of assets and liabilities, etc.;

  • all transactions that have a potential monetary value are recorded;

  • at the same time, the fact of payment of money is not necessary.

11. Principles of revenue accounting. According to international financial reporting standards, the company should recognize revenue when certain conditions are met.

We have covered all the principles of GAAP accounting. But I want to draw your attention to 5 basic principles when opening a new business.

Further business consulting considerations are covered here in common examples of conservatism in accounting standards, including the following:

  • Research and development costs. Because the future economic benefits of research costs are uncertain when the costs are incurred, GAAP requires an immediate cost write-off instead of capitalization.

  • Legal costs. When it is "likely" and only increase these costs when legal obligations start to increase.

  • Indemnification for insurance losses. Typically, a company that expects to receive payment on an insurance claim may not recognize a receivable until the insurance company has confirmed the amount claimed.

  • Under the sales principle, a company cannot take into account revenues when products are only manufactured or only planned to provide services. For example, in January, the company was awarded a contract to paint a house. The painting was done in February, and the company received the money for the work in March. The company should post paint income in February when the service was rendered.

  • The compliance principle states that income tax should be calculated based on accounting and not taxable income. For example, the accounting profit of a business was $ 2,000,000, and the taxable profit was only 1,100,000. If the amount of tax on profits is 35%, then the tax in absolute terms will be $ 385,000 = $ 1,100,000 x 0.35. If the calculation of this value were made from accounting and not taxable profit, then its amount would be $ 700,000 = $ 2,000,000 x 0.35.

As you can see, the amount of tax paid by the company ($385,000) turned out to be less than the amount of tax calculated from the accounting profit. In other words, the amount of tax of $ 385,000 does not correspond to the amount of accounting profit, and there is a violation of the principle of compliance.

If the amount of accounting profit is $ 2,000,000, and income tax is 35%, then the company must show in its financial statement's income tax expenses in the amount of $ 700,000.

Since the amount of tax paid by the business was $ 385,000, the difference between these two amounts must be accounted for in a special way. This difference is equal to $ 315,000 = $ 700,000 - $ 385,000, it is called “Deferred Income Tax”. In the balance sheet, the line by which this value is shown is included in the "Liabilities" section.

Accrual accounting allows a company to record revenue in the income statement at the time of a sale. These revenues are then transferred to accounts receivable on the balance sheet and may result in operating expenses in the operating part of the cash flow statement if payments are not received. This method gives a clearer picture of the company's activities and actual sales trends, not just when the payment is received.

Revenue accounting conditions:

  • The company has provided all or most of the services it should provide to the client.

  • The company has incurred all or a significant part of the cost of providing these services. The rest of the costs can be estimated reasonably accurately.

  • The company has received from customer cash, payment obligations, or some other asset for which:

  • you can quite accurately determine its cost;

  • you can be fairly confident that the obligations transferred by this client to the company will be fulfilled by him.

GAAP is just a set of standards. Thus, when starting a new business, do not forget about these principles; they ensure the completeness, consistency, and comparability of the company's financial statements. It also makes it easier for investors to analyze and extract useful information from the financial statements and compare financial data for various companies.

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