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Conceptual Framework and Principles

Conceptual Framework and Principles

Author: Evan McLaughlin
In this lesson, the student will learn about some key principles underlying the practice of accounting.
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"Conceptual Framework and Principles"

Source: Instrumental “Drops of H2O ( The Filtered Water Treatment )" by J.Lang (feat. Airtone),” Creative Commons, http://ccmixter.org/files/djlang59/37792

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Hey everyone, and welcome to our video, today, on the Conceptual Framework and Principles. So what are today's discussion topics? Well, we're going to talk about principles, principles, and then some more principles. We're also going to talk about the accrual versus the cash basis. And, when we talk about that, we're going to talk about what is GAAP and what's not GAAP.

Well, let's get started on our key accounting principles, starting with the measurement/cost principle. The measurement/cost principle is that accounting is based on actual costs. The common measurements used for the measurement cost principle, and in accounting, would be historical cost, as well as the fair value.

Second principle-- our matching principle-- this deals with revenue recognition, which is that revenues are recognized when they're earned-- keyword, there, being "earned." The other matching principle is the expense recognition principle, which is that expenses are recorded when incurred, to generate revenue. That's where we get our match. So we're matching our expenses that are used, that we have to spend, when we generate our revenues. We're matching our expenses with our revenue.

Full-disclosure principle-- keyword, there, being "disclosure." So a company must report all the details behind the financial statements that may impact user decisions. So there's that key of the full-disclosure principle-- influence decision-making. So if it influences decisions, information must be provided, in the financial statements, or the notes to the financial statements.

Another key principle is the time-period principle. A company must have consistent and consecutive periods of reporting, whether that's monthly, quarterly, annually. So those are four key principles. Now, let's talk about some additional principles that we have, in accounting.

We have verifiability, which is that the accounting information can be independently verified. There's also the principal of economic entity, which is that a company is separate from owners and other businesses. We have our monetary-unit principle, which is that transactions are denominated in currency. That depends on your country's native currency. So US-based businesses, transactions are denominated in dollars, whereas, if you're over in Europe, transactions would be denominated in euros.

Materiality; that is that, if error or omission would influence the decisions, then that information is considered material. And going concern; that's that a company will be able to continue to operate, to fulfill its commitments.

We're going to keep going with these additional principles; just a few more. We have objectivity; information provided cannot be biased towards one user group. So the information has to be objective. Understandability; the quality of information that can be understood by reasonably informed users. So reasonably informed users need to be able to understand the information that you've put into your financial statements.

Reliability; the information provided is complete and free from material error. So we've provided all the information; it's been checked for errors. OK? So it's reliable. And last one, comparability; information reported for different companies is reported similarly. So, if we're looking at two different companies, they report in such a way that we can easily compare Company A and Company B. So those are some of our additional principles.

Now, let's talk about this accrual versus cash basis. So accrual basis; everything hinges on the revenue and expense recognition, when we're looking at the difference between these two. So, starting with accrual basis, revenues are recognized when earned. Now, under the cash basis, revenues are recognized when cash is received.

Now, let's look at our expenses. The accrual basis recognizes expenses when they're incurred, whereas the cash basis recognizes expenses when cash is paid. So let's start with that accrual basis. So these are where we get our principles-- our revenue, and our expense, our matching principles. Those are really guiding us, in accrual basis. And accrual basis is our GAAP basis of accounting. So this is the type of accounting that we have to use for GAAP.

Now, cash basis-- cash really drives recognition. We're not concerned with matching our revenues with our expenses, when they're incurred. It's purely based on when cash is paid and cash is received. And the cash basis of accounting is not GAAP.

OK. So let's summarize what we talked about, today, in a nutshell. We looked at key principles of accounting, which would be our measurement/cost principle, our full-disclosure principle. We looked at time-period principle, revenue recognition, and expense recognition. OK, those are our key principles of accounting. And then we also talked about several additional principles which are useful.

And then our last topic of the day is, we talked about accrual basis versus cash basis. And remember, our accrual basis-- that's our GAAP basis of accounting. So that's what we use in GAAP.

I hope everybody enjoyed this video, and I hope to see you next time.