Accounts are records of financial transactions, where the information about how much has been spent and how much has come in, is entered onto a sales ledger. The completed ledger can be manipulated to produce reports and this helps with financial planning.
In preparing accounts there are several accounting principles which must be followed:
This assumes that a business will continue to trade in the future.
The same principles must be used for every set of accounts that is prepared. For example, depreciation must always be set at the same percentage. This means that different sets of accounts can easily be compared to see trends and growth rates.
Accountants should always err on the side of caution in their estimates and valuations. For example if revenue were to be over-estimated dividends may appear to be due to shareholders that have not actually been earned.
Sales and costs are considered to be incurred at the point that the sale is made and delivered, rather than when the company is actually paid. This means that sales which have been secured, perhaps in the form of orders taken but not yet delivered, will not be taken into account.
This is about the relative importance of individual transactions. Most parties will only be interested in significant amounts. This means that lots of low value sales for one customer could be combined together. However if combining transactions could mislead the user of the accounts the amounts should be split out.
When looking at fixed assets, such as fully owned buildings and machinery, only the original cost of the item is recorded. Its actual value may be quite different, perhaps due to rising property prices, but to calculate a value would make the accounts subjective.
Financial transactions from one person or group of people should be isolated from other unrelated transactions from the same person or group. For example, a sole trader may be withdrawing money for their salary but this would be classed as two transactions because the owner is receiving money and the business is paying out money.
Transactions that happen over a period of time must reflect a single currency and exchange rate. This will allow one year’s set of accounts to be compared with another regardless of the rate of inflation.
Duality dictates that every transaction has two effects. For example, if a company buys a new asset such as a new printing machine, then fixed assets must be shown to increase and either cash or liabilities must also show an increase.
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