Let's begin by discussing four key accounting principles:
The chart below details some additional principles in accounting:
|Verifiability||The accounting information can be independently verified.|
|Economic Entity||A company is separate from owners and other businesses.|
|Monetary Unit Principle||Transactions are denominated in currency, depending on a country's native currency (e.g., for U.S.-based businesses, transactions are denominated in dollars, whereas in Europe, transactions are denominated in euros.)|
|Materiality||If error or omission would influence decisions, then that information is considered material.|
|Going Concern||A company will be able to continue to operate to fulfill its commitments.|
|Objectivity||Information provided cannot be biased towards one user group; the information must be objective.|
|Understandability||The quality of information that can be understood by reasonably informed users, meaning reasonably informed users need to be able to understand the information in the financial statements.|
|Reliability||The information provided is complete and free from material error, and therefore reliable.|
|Comparability||Information reported for different companies is reported similarly (i.e., Company A and Company B must report in such a way that they can be easily compared).|
Now, let's talk about accrual basis versus cash basis. Under accrual basis, everything hinges on the revenue and expense recognition:
Our principles--our revenue, our expense, and our matching principles--are guiding us in accrual basis. Also, accrual basis is the type of accounting that we must use for GAAP.
In contrast, under the cash basis:
Under cash basis, cash drives recognition. We're not concerned with matching our revenues with our expenses when they're incurred. It is purely based on when cash is paid and cash is received. Also, the cash basis of accounting is not GAAP.
Source: Adapted from Sophia instructor Evan McLaughlin.