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LaiACCT1200/20 (lecture 2)
ADA University, School of Business
ACCT1200 Principles of Financial Accounting, Spring 2020
Lecture 2 – Accounting Principles
• Why the need for accounting principle, policies or standards? so that accounting
statements / information prepared by different entities will be done on the same basis
(similar argument to having rules for soccer, so that the game played in Azerbaijan will
be the same to the game played all over the world). Can you imagine a situation where
every entity is allowed to devise their own accounting rules?
o Principles and policies are more general in scope, while standards are more
specific, relating to specific accounting items. This lecture will focus on
accounting principles.
• The accounting principles / policies, as we can identify them today, evolved gradually
over the years and became generally accepted as conventions. Indeed, the ultimate aim
of the International Accounting Standards Committee (IASC) is to devise a conceptual
framework of accounting or generally accepted accounting principles (GAAP) which
will be adopted by accountants all over the world.
• Accounting principles can be classified into the following categories:
o Boundary rules – determine what should and should not be reported; limit the
amount and type of data collected and reported.
(a) Separate Business Entity – the entity / corporation is separate and distinct
from its owners. What the directors do in their personal capacity is
distinct and separated from the transactions of the company.
(b) Time period / Periodicity – it is conventional for accountants to use a time
period of one year to prepare the financial statements of an entity.
Examples of financial years are calendar years, fiscal years and normal
business activity years.
(c) Transaction Approach / Monetary measurement – accountants only record
events that can reasonably be determined in monetary terms. The
disadvantage of this rule is that certain important events which affect the
financial position of companies will not be recorded in the financial
statements, for example, employee strike actions, resignation of senior
managers.
LaiACCT1200/20 (lecture 2)
o Measurement rules – explain how accounting data should be recorded.
(d) Historical cost – this concept requires that assets be recorded at the value
of their original or historical cost even though this may differ from
current / present / market cost. An exception to this rule is allowed if the
current or market cost is less than the historical cost. After more than
three decades of trying, there is still no agreement on accounting for
inflation.
(e) Realization / recognition rule – determines when a transaction is regarded
as “realized / recognized” and can be entered in the accounts. In financial
accounting, the two main basis of realization / recognition are:
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Cash basis or cash flow accounting – revenue or expenditure is realized
/ recognized and recorded based on the flow of cash. Revenues are not
recorded until received in cash; and expenses are assigned to the
period in which the cash payments are made.
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Accrual basis – revenue or expenditure is realized / recognized at the
point of sale or purchase (transactions to be entered in the accounts for
that period in which the legal title for them has been transferred from
one party to another); which may not be similar to the receipt or
disbursement of cash. The accrual basis of accounting recognizes
